Headwinds for global bonds and stocks

Stocks have slipped and yields have risen over the past time.

According to the Stock Trader’s Almanac, the first five days of the year in the S&P 500 correctly determine the direction for the full year over 80% of the time. If you believe this story, given that the S&P fell 2% in the first five days of this year and is now down by more than 5%, it seems to bode ill if you believe this.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy said he doesn’t know whether the same claim is made for treasuries but, if it is, 2022 may turn out to be a bit of a howler as well. When faced with these sorts of statistics, our reply is usually that history is a good guide to the past. Hence, nothing today is the same as it was in the past, and hence historical patterns are probably random. For instance, just looking at the situation today, we can certainly say that the current position is different to the past. When did the Fed ever start the year with 7% inflation and a fed funds rate barely above zero? But, perhaps ironically, this observation might be a clue as to why 2022 could be a bad year for assets, just as the first five-day slide in the S&P would suggest", Mr. Steve Barrow stressed.

Mr. Steve Barrow’s view is that a significant amount of asset price strength in bonds and stocks for many years has been attributable to central bank largesse and, in turn, this largesse has been driven by the fact that there’s been no inflation. But now there’s inflation in abundance, and that presents two problems.

The first is that central banks need to take the liquidity back in a way that does not freak out the markets, but still creates the tightening of financial conditions necessary to bear down on inflation.

The second is that, if an adverse shock occurs, caused by central bank missteps or some other factor, like a new deadlier Covid variant, central banks won’t be able to put the punch bowl of liquidity back on the table as they have in the past. In other words, the assumption that central banks, led by the Fed, still have investors’ backs is not applicable as long as inflation remains entrenched. That’s a very different scenario from recent decades. But while this might seem a worrying thought, there’s little sign that investors are running scared of a huge rout in risk assets like equities.

On the contrary, allocations to equities among investors remain heavily overweight while they are underweighting bonds. This might not be surprising given that the market has already seen off some potentially scary events. One of these, of course, is the rise in inflation itself and the associated surge in rate-hike expectations, particularly in the US and UK. But even away from this, the Omicron outbreak has hardly knocked asset markets out of their stride, nor too the Evergrande saga in China, and that’s despite the fact that the bears have long argued that a Chinese event like this had the scope to unseat asset prices globally, not just domestically.

But, like many things, the bulls can come up with a riposte, which, this time, seems to be the delivery of policy easing from the PBOC as we saw last week. This ability of the market to see things through rosy-tinted glasses never ceases to amaze and, because of central bank largesse, usually proves correct. But this largesse is unwinding, and the key is whether this is a process that the markets will be able to see off as easily as they appeared to see off Omicron and Evergrande’s collapse.

The key is probably inflation; whether it comes down as policymakers suggest or not. If it does, the early wobbles in stocks and bonds this year should prove temporary. If not, the Stock Trader’s Almanac might have another tick to put against its 5-day prediction. "Our view is that inflation won’t come down as fast as policymakers predict and, hence, the headwinds for bonds and stocks should be strong this year." Does this mean some sort of crash? No, probably not. A crash scenario occurs if there’s an adverse shock to the global economy that central bankers can’t offset because their hands are tied by high inflation,", Mr. Steve Barrow said.