A bear market is defined as an index or market drop of greater than 20% from its peak. The S&P 500 Index officially entered bear market territory on Monday, June 13, closing almost 22% down from its January 3 peak.1 That peak coincided with the release of the minutes from the U.S. Federal Reserve’s December 2021 meeting. Those minutes changed the markets’ perception of the Fed’s rate hike path and yields across the curve began to spike. Since January 3, the 2-year yield has jumped 245 bps and the 10-year jumped 174 bps.1 Not surprisingly, this is on the back of persistently high inflation and the belief that the Fed will raise rates as high and fast as needed to get it under control and perhaps even causing a recession to do so.
All eyes were firmly locked on the Fed’s decision on Wednesday, June 15 and the subsequent press release and conference. Although Fed Chair Jerome Powell stated last meeting that the committee wasn’t looking at the potential to raise their overnight rate by 75 bps, a lot has changed since that meeting. The recent uptick in headline Consumer Price Index (CPI) data to 8.6% coupled with rumours in the media, resulted in the market fully pricing in a 75-bps rate hike prior to the meeting.1 And that’s exactly what the Fed delivered.
Prior to the meeting, the market was pricing in twelve 25-bps rate increases by the Fed between now and their February 2023 meeting, with a target federal funds rate of 4%.1 However, following the rate hike announcement and the press conference, those expectations have tempered a bit, with the target rate closer to 3.75%. We saw a broad U.S. equity market rally on the slightly less hawkish sentiment.
More often than not, the market is overly aggressive in expectations for Fed rate hikes.
While there’s no denying that inflation, as measured by the Consumer Price Index, remains extremely high at 8.6%, there are aspects that indicate we‘re getting closer to a peak. Core CPI—which strips out the more volatile components of headline CPI, food, and energy—actually fell slightly the last two months, from 6.5% to 6.0%.1 While that doesn’t necessarily help end consumers and their pocketbooks, we could argue that food and energy prices are less controlled by Fed policy.
It’s also important to understand that inflation is a backward-looking calculation and doesn’t turn immediately on interest rate changes. The bond and equity markets tend to act like a pendulum and often swing too strongly in both directions. Any change in Fed tone toward a less hawkish approach to rate hikes could cause the pendulum to swing back the other way. We witnessed a bit of that after the Fed announcement. While we’re in the latter stages of this economic cycle, the current extreme moves might be overexaggerated. History has shown that when equity markets are volatile as indicated by the CBOE Volatility Index (VIX), it can be an opportunity for the patient, long-term investor.
While it’s near impossible to call the bottom of the market, investors with cash on the sidelines have been waiting for this bear market to deploy capital. Recession risks have no doubt increased since the start of the year, but we believe a “real recession,” where unemployment skyrockets, remains unlikely in 2022 and market fundamentals—including valuation and earnings—remain decent. Once we have some clarity on the current challenges, markets will have likely rallied, leaving investors behind. Think back to several weeks ago; while it was too early to call the rally a pivot in sentiment, it does highlight how quickly markets can move. The S&P 500 Index was up nearly 9%, on a price-return basis, over a six-day period as less hawkish commentary from a few U.S. Federal Reserve Governors, China reopening, and good earnings supported positive investor sentiment.1
While investors may remain jittery, it’s important to remember their longer term goals. Patience is a virtue.
1 Source: Bloomberg, as of June 15, 2022
A rise in interest rates typically causes bond prices to fall. The longer the average maturity of the bonds held by a fund, the more sensitive a fund is likely to be to interest-rate changes. The yield earned by a fund will vary with changes in interest rates.
Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a fund’s investments.
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