A common warning on Wall Street for a decade is that trading desks have been overrun by people who are too young to know what it’s like to navigate a Federal Reserve tightening cycle. They’re finding out now.
In markets, there’s turbulence, then there’s whatever you call the last two days, when a 900-point Dow rally was followed 12 hours later by a 1,000-point decline. Hundreds of billions of dollars of value are conjured and incinerated across assets in the space of a day lately, a stark reversal from the straight-up trajectory of the post-pandemic era.
Where once every dip was bought, now every bounce is sold. Thursday was only the fourth day in 20 years in which stocks and bonds each posted 2%-plus declines, going by major exchange-traded funds that track them. Concerted cross-asset stress of that magnitude reliably spurs speculation that big funds are being forced to sell.
“I’m scared like everybody else,” said Jim Paulsen, chief investment strategist at Leuthold Group and one of Wall Street’s most visible bulls. “I’ve been in the business almost 40 years now– these things don’t get any easier, because you never know for sure and you also know you’ve been wrong in the past.”
Behind the churn is a Fed committed to what will likely be the most aggressive withdrawal of stimulus for the economy since 1994. Once an anchor of stability for the market, the central bank is now its chief antagonist, sworn to subdue the hottest inflation in four decades.
“Clients are calling and saying, ‘So are we done yet? Should we be concerned? Should we put it all under the mattress?’” Paul Nolte, portfolio manager at Kingsview Investment Management, said by phone from Chicago. “This feels a little bit more like 2000, 2002, where it’s just a steady persistent decline punctuated by some rallies.”
Fed disruption is everywhere. On Wednesday, after Chair Jerome Powell signaled that a rate increase of 75 basis points is off the table for coming meetings, stocks rallied, sending the S&P 500 to the biggest post-Fed gain in a decade. Then the market buckled Thursday, with the index falling more than 3.5% as traders reassessed the landscape.
Over the past 25 years, only three other Fed policy meetings have seen big market reversals of this size to the downside over the first two days.
“What a difference a day makes,” said Frank Davis, senior managing director at LEK Securities. “Yesterday people were reading into the Fed’s comment seeing some predictability and stability. But now that looks like a big headfake.”
Virtually every asset is suffering from central bank-induced turmoil. The dollar, down almost 1% on the Fed day, staged a full recovery Thursday to approach a 20-year high. In fixed income, 10-year Treasury yields erased Wednesday’s slide, topping 3%.
Few are expecting the cavalry to ride in any time soon, or the plunge-protection team. The Fed has been hamstrung by inflation and needs financial conditions to tighten to help slow down the appreciation of prices for food, cars and shelter. While Powell has repeatedly expressed confidence in achieving a soft landing in the economy, the risk of a recession is a threat investors can’t afford to ignore, according to Dennis DeBusschere, the founder of 22V Research.
“This is why every rally needs to be sold,” DeBusschere said. “Because higher risk assets mean you don’t fight inflation! You have no way out!!” he added. “Who the heck is going to step into this tape?”
In fact, 2022 is shaping up to be the most painful year for dip buyers in decades. Since January, the average drop in the S&P 500 has lasted 2.3 days, more than any year since 1984, while its returns following down sessions have been negative 0.2%. That’s the worst in 35 years.
Investors, conditioned to the success of dip buying for most of the past decade, are spooked by the new experience, exiting equity-focused funds in April at one of the fastest paces in years.
To Greg Boutle, U.S. head of equity and derivative strategy at BNP Paribas, Wednesday’s bounce was “the hallmark of bear market rally.”
“Positioning has been very defensive into this move, which to some extent could mitigate a sense of panic or forced selling,” he said. “But the price action today, it’s hard to read as anything other than problematic in the very short term.”
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