Why do stocks go down? What you need to know about bear markets, stagflation, and the crypto mayhem

It will take more than Friday’s big bounce to quell fear of a bear market in stocks as uncertainty about the Federal Reserve’s ability to control inflation without flooding the economy raises fears of stagflation – a pernicious combination of slow economic growth and persistent inflation.

Recessive inflation is a “horrific environment” for investors, said Nancy Davis, founder of Quadratic Capital Management, and typically results in stocks and bonds losing value simultaneously and playing havoc with traditional portfolios split 60% into stocks and 40% into bonds.

This was already the case in 2022. Bond markets lost steam as Treasury yields, moving opposite prices, rose in response to inflation hitting its highest levels in more than forty years combined with expectations of strong monetary tightening by the Federal Reserve. Since the S&P 500 index’s record close on January 3 of this year, stocks have been in a slide that has left the large-capitalization benchmark on the verge of officially entering bear market territory.

iShares Core US Aggregate Bond ETF AGG Fund,
-0.43%
It’s down more than 10% year-to-date through Friday. It tracks the Bloomberg US Composite Bond Index, which includes Treasury and corporate bonds, monies, mortgage-backed securities and asset-backed securities. S&P 500 SPX Index,
+ 2.39%
It is down 15.6% from the same stretch.

Analysts at Montreal-based PGM Global wrote, in a note last week, that the situation “leaves practically nowhere to hide.”

“Not only are long-term Treasuries and investment-grade credit moving roughly one-on-one, but sell-offs in long-term Treasuries also frequently coincide with the S&P 500 pullback days,” they said.

Investors looking for solace were disappointed on Wednesday. The much-anticipated US consumer price index for April showed that the annual pace of inflation slowed to 8.3% from a more than four-decade high of 8.5% in March, but economists were looking for a more pronounced slowdown, and the core reading, which dumps that. The volatile food and energy prices showed an unexpected monthly rise.

This confirms the fears of stagflation.

Davis also serves as portfolio manager for the Quadratic Fund for Volatility and Inflation Hedging at IVOL,
+ 0.69%And
With approximately $1.65 billion in assets, which is intended to act as a hedge against increased fixed income volatility. She added that the fund holds inflation-protected securities and is exposed to the difference between short and long-term interest rates.

She said in a phone interview that the interest rate market is currently “extremely satisfied,” indicating expectations that a Fed rate hike would “create an adverse environment for inflation,” when tightening is unlikely to do anything to solve supply-side problems. that has plagued the economy in the wake of the coronavirus pandemic.

Meanwhile, analysts and traders have been debating whether the stock market’s bounce on Friday heralds the start of the bottoming process, or just a bounce from oversold conditions.

“After a week of heavy selling, but with inflationary pressures easing only on the sidelines, the Fed still appears to be committed to a 50 basis point hike for each of the next two phases. [rate-setting] Quincy Crosby, chief equity strategist at LBL Financial, said the market was primed for the kind of strong rebound that is endemic to take on market rallies.

It was a huge bounce. Nasdaq Composite,
+ 3.82%And
Which slipped into a bear market earlier this year and slumped to a 2-1/2 year low last week, jumped 3.8% on Friday for its biggest one-day percentage gain since November 4, 2020. That pared its weekly decline. to 2.8%.

The S&P 500 rebounded 2.4%, trimming its weekly decline by nearly half. That sent the large-cap US benchmark down 16.1% from its record close in early January, having finished on Thursday close to the 20% decline that would meet the technical definition of a bear market. Dow Jones Industrial Average DJIA,
+ 1.47%
It rose 466.36 or 1.7%, leaving with a weekly decrease of 2.1%.

Read: Despite the rebound, the S&P 500 is getting dangerously close to a bear market. This is the important number

All three major indices are long weekly losing streaks, with the S&P 500 and Nasdaq both dropping for six consecutive weeks, the longest stretch since 2011 and 2012, respectively, according to Dow Jones market data. The Dow has booked its seventh straight week of losses – the longest running streak since 2001.

The S&P 500 hasn’t officially entered a bear market, but analysts see no shortage of stock exchange behavior.

As Jeff Degraaf, founder of Renaissance Macro Research, noted on Wednesday, correlations between stocks were running in the 90s to 100s, meaning choppy performance indicating that stocks were trading largely in unison — “one of the hallmarks of a bear market.”

While the S&P 500 moved “uncomfortably close” to a bear market, it’s important to keep in mind that large stock market dips are normal and occur frequently, analysts said. Barrons noted that the stock market has seen 10 bear market dips since 1950, many other corrections and other major pullbacks.

Randy Frederick, managing director of trading and derivatives at the Schwab Center for Financial Research, said in a phone interview that the speed and scope of the recent rally could leave investors jittery, especially those who haven’t experienced a volatile slowdown.

He pointed out that the rise witnessed “the rise of every sector in the market.” “This is not a normal market” and now the worm has turned as monetary and fiscal policy tightens in response to hyperinflation.

He said, “It’s not fun at the moment, but that’s how the real markets work.”

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