Does the market action and outlook resemble early 2016 or late 2018? Let’s recap those time periods to help the reader at home:
2016: Economy in mid-cycle
The Fed did its best Grinch impersonation by starting its post-global financial crisis (GFC) rate hiking cycle on Dec 5, 2015. Sniffing out the rate hike a few days before, the S&P 500 started selling off, ultimately resulting in a -13% decline over roughly a two month stretch. However, the equities market rallied the rest of the year, recouping the January and February losses and finishing up 9.5% on the year (11.9% total return), according to the S&P 500. In 2017, the market posted a total return of 21.8%.
Side note: After a dismal performance for roughly 2.5 years post taper tantrum, emerging market equities outperformed posting a total return of over 80% from early ’16 – early ’18, according to the MSCI Emerging Markets Index. We believe the asset class is worth watching after dismal ’21 performance.
2018: Economy in late-cycle
In 2018, monetary policy turned restrictive as the Fed was on the backside of nine hikes (peaking at 2.5%). The economy started feeling the effect, with GDP only growing 1.4% in the second half of 2018. Corporate profits slow sharply in the second half of the year and contract in the first quarter of 2019. Equity markets post a decline of -6.2% for the year (-4.3% total return), according to the S&P 500, and risk adjusted returns were very poor.
Exhibit 1: Fed Funds Target – Upper Limit
Yes, every cycle is different. But to us, the macro backdrop is much more aligned with 2016 than 2018. Specifically because:
- Unless something changes drastically in the macro picture it is still supportive for risk assets. The economy is slowly normalizing, currently in mid-cycle, consistent with central banks starting their policy tightening.
- The market is already discounting four rate hikes this year and three next year. We believe it will take a lot to raise that bar higher.
- Earnings should be decently higher a year from now while ramped up buybacks and M&A will likely add support. Also, the credit markets aren’t sending any warning signs of impending doom.
- Technicals show the crowd is very fearful right now; the Ned Davis sentiment indicator went into extreme pessimism (bullish) for the first time since the start of the pandemic; put/call ratio is off the charts (people very fearful, buying protection).
- Frankly, what we see is a rotation trade out of the frothy speculative stuff (bitcoin-related, non-profitable tech, IPOs, etc.) into quality (hello FTSE 100), which echoes our Global House View: ‘The Beta trade appears to be over, prefer quality assets that are levered to above-trend nominal growth, but are price sensitive given mid-cycle. This ‘grind phase’ of the markets tests patience and nerve, returns more pedestrian, utilize pullbacks.
- This pullback was long overdue, but unless the 10-year Treasury is going to zoom to 3%, we would caution extrapolating too far under current conditions (i.e., that this is a much larger/longer cycle ending correction).
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