It was, as one economist put it, “a brutal day in risk markets” when on September 15, the S&P 500 lost 4.7% – its biggest one-day decline in seven years. “A lousy day for stocks,” he added. The “locusts” were taking their toll in global equities, another market watcher agreed.
The verdict on the front page of this newspaper was brutal. “Judgement Day on Wall Street,” the headline read, along with a large photo of dejected-looking bankers in Canary Wharf.
If you think something is wrong here, you’re right. That September 15 market shock was in 2008, not 2022. These discouraged bankers stood outside the European headquarters of Lehman Brothers and Bank of America had just swallowed Merrill Lynch as the global financial system unraveled.
Fast forward almost exactly 14 years and history doesn’t repeat itself, but it certainly rhymes.
This time around, on September 13, the benchmark S&P 500 index of US equities fell more than 4% – a drop the likes of which has not been seen since the start of the Covid crisis more than two years ago. . The Nasdaq Composite fared even worse, losing 5.2%. As bizarre as it may sound, the post-Covid recovery phase of 2022 is producing moments in the market as ugly as the week Lehman Brothers told shocked staff “it’s over.” Even weirder: somehow, we got used to the beatings.
Perhaps it’s because investors have been swooning every time this year that US inflation data has been surprisingly strong. This week was no exception. Consumer price inflation in the United States hit 8.3% in August, according to figures released Tuesday by the Bureau of Labor Statistics. This is a little better than the 8.5% figure for July. The problem is that analysts and investors were expecting a more moderate pace of 8.1%, especially given the rapid pullback in gasoline prices. The rate also rose 0.1% in August from the previous month.
Again, this torpedoed the US Federal Reserve’s much-desired pivot – the mythical moment when it decides to scale back the interest rate hikes that have sent asset prices skyrocketing this year. Again the hopeful pundits are disappointed and the beatings will continue until morale improves.
Traders now see a reasonable chance that the Fed will hike rates a full percentage point at next week’s meeting. Anything less than three quarter points would be a huge surprise.
BlackRock rather gnomically compares this to Knut, the polar bear. For those who had forgotten Knut’s story (myself included), the investment house recalls that the little newborn was rejected by his mother at the Berlin Zoo in 2006.
“A zookeeper intervened to raise him on a bottle. But some argued that it was better for the bear to be killed than raised by humans,” wrote Jean Boivin and Alex Brazier. “A media frenzy and widespread protests followed, ultimately saving Knut’s life. In our view, central bankers seem to have a bit of a “let the bear die” mentality at the moment (for bears, read economics). It seems that they simply prefer to let the economy die to avoid any risk of unanchoring inflation expectations.
Basically, where the economy goes, your wallet probably follows. Maybe it’s time to find a friendly zookeeper or sympathetic protesters.
The point is, as all but the youngest polar bears surely know, this is nothing new. So why does the market convulse every time it receives a callback? “It’s the attempt to triumph over hope over experience,” says Trevor Greetham, multi-asset head at Royal London Asset Management. “If you had told any of us three years ago that we risked 22% inflation in the UK if there had been no government action on energy prices , we wouldn’t have believed you. This is a massive regime change. People always want inflation to be transient and temporary. It’s not.
Along with 2008-style stock declines, all of this is generating huge swings in the dollar and the generally more subdued government bond market. Some analysts worry that longstanding structural flaws in the debt market are becoming dangerous. BofA described the cracks in US Treasuries as “one of the biggest threats to global financial stability today, potentially worse than the housing bubble of 2004-2007.” If the ripples are left unchecked, quantitative tightening — the process by which the Fed shrinks its balance sheet in times of crisis — could prove to be the factor tipping this market.
We should all hope not and many of these technical details are white noise for non-specialists. But Greetham puts it deliciously simply: “Whether it’s QT or just an almighty central bank misstep by the Covid crisis, it’s the same thing.” Hindsight is a beautiful thing, but it is becoming clearer by the day that markets have been propped up too generously by central banks for too long. Correcting this imbalance will continue to trigger the horrendous declines and bear market false bounces that characterized the 2008-2009 crisis.
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