A global bear market in financial assets has been raging for months and shows few signs of abating. The MSCI global stock index lost about 22% from its high last autumn. Emerging-market stocks have lost about 30% since their high early last year. But most striking is how badly other assets have done at the same time, notably government and corporate bonds. Indexes of seven-to-10-year US Treasuries and investment-grade corporate debt have lost about 10% and 13% respectively this year.
If you’re still holding out hope that the Federal Reserve will be able to engineer a soft landing in the US economy, abandon it. A recession is inevitable within the next 12 to 18 months. the new focus on price stability will be relentless. Fed officials recognize that failing to bring inflation back down would be disastrous: Inflation expectations would likely become unanchored, necessitating an even bigger recession later. Powell does not want to repeat the mistakes of the late 1960s and the 1970s.
Economic history points to a hard landing. The Fed has never tightened enough to push up the unemployment rate by 0.5 percentage points or more without triggering a recession. when this trigger is reached the next stop is a deeper slump, in which unemployment increases by at least 2 percentage points.
Powell said for the first time that a recession may not be avoided, fueling a rally in the bond market that was later pared after he vowed that the Fed's fight against inflation is "unconditional."
Federal Reserve Bank of Cleveland President Loretta Mester said the risk of a recession in the US economy is increasing, and that it will take several years to return to the central bank’s 2% inflation goal. The Fed will need to see “compelling evidence” in month-to-month data that price pressures are easing before it is convinced that prices are under control, she said.
Bloomberg Economics says there’s close to a three-in-four probability there will be a recession by the start of 2024. Economists at Deutsche Bank AG, one of the first major banks to forecast a recession, now expect one to begin in mid-2023; Wells Fargo & Co. predicts the same. Nomura Holdings Inc. expects one even sooner, starting at the end of 2022. The likelihood of a recession could climb even higher if gasoline prices continue to rise and the Fed opts for another 75-basis-point rate hike in July. (When the central bank raised interest rates by that much in June, it was the biggest such move since 1994.)
The S&P Global flash June composite purchasing managers index slid 2.4 points to 51.2, the group reported Thursday. While still above 50, and therefore indicating growth, the reading was the second weakest since July 2020, when the economy was clawing its way out of a pandemic-induced recession. “The survey data are consistent with the economy expanding at an annualized rate of less than 1% in June, with the goods-producing sector already in decline and the vast service sector slowing sharply,” Chris Williamson, a chief business economist at S&P Global Market Intelligence, said in a statement.
In US manufacturing, growth slowed abruptly with the S&P Global index dropping 4.5 points to 52.4 in June, one of the largest monthly declines in data back to 2007. Production swung from solid growth last month to contraction in June as high prices, weaker demand, and materials shortages combined to push the output index to a two-year low.
Where does the stock market go from here? It’s difficult to write much about markets with the huge uncertainty that we have right now, but if history can provide us with any clue when can we expect the stock market to bottom when the Fed reaches a peak in raising interest rates then begin to lose its monetary policy. The chart below shows the last three bear markets with the federal fund rate.
Based on the below chart that shows the relationship between the bear market and monetary easing policies we expect the bear market to continue to the second quarter of 2023.
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The chart below shows the expectation of the interest rates based on the Fed June dot plot, the swap overnight index, and the Eurodollar future so the market expects the interest rates to reach their peak between March and July next year.
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Global stock investors may be excited about the gains last week but the rally is looking like a run for defensive plays rather than a risk-on roar. A Goldman Sachs Group Inc. index of defensive stocks including megacap tech and healthcare names has climbed to more than an 18-month high relative to the MSCI AC World Index, as fears of a global recession outweigh concern over sky-high inflation. The gauge has jumped over 4% this week, double the rise in the global stocks benchmark itself on track for its first weekly gain in four. The fall in bond yields has been particularly helpful to defensive growth stocks, which had been under pressure from the rise in interest rates undermining valuations. “Investors are shifting their focus from rate risks to EPS risks. That may take some pressure off growth stocks, but remains troublesome for cyclical,” Citigroup Inc. strategists including Robert Buckland wrote in a note on Thursday. “Defensive Value looks desirable.”
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