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The post-pandemic US stock market rally is over. The S&P 500 closed sharply lower on Monday, eventually breaking the 20% bear market barrier from its all-time high on Jan. 3, 2022 to nearly 21.8%.
Bear markets matter. A fall in investment of more than 20% does not necessarily have to have an impact. Because what exactly is the difference between 20% and 19.8%? (See December 2018.) However, they are very symbolic. The market is once again undergoing a physical contraction amidst all the short-term challenges and long-term opportunities.
The importance is not only in what happens in the stock market. The furious return of inflation is causing excitement in the bond markets. So much so that bonds don’t offer the same level of security that they have had in the past. that’s unusual. On Friday, June 10th, US and global bond market aggregates are down 11% and 14% year-on-year, respectively.
Criminal? Rising interest rates. As bond yields rise, bond prices fall – and the historically sharp rise in interest rates over the past year has led many investors to ask “why own bonds?”. The answer is twofold.
The long and short of it
The adage buy short and sell high doesn’t just apply to stocks. Yes, the past year has been a painful transition, but with the past, today’s shift to higher yields makes it a better place to start for bond investors. Instead of accepting ultra-low interest rates (e.g. 1%), investors can now earn low to medium single returns on a wide range of securities – without having to access the riskier parts of the market. That’s good news for reinvested principal payments and ongoing coupons.
In addition, the bond market offers investors long-term diversification benefits in several asset classes. A gain that is generally true and especially valuable in a down market. Should the economy slow down enough to slide into recession, we believe investors will seek safety amid the storm, as they always have. That means buying safer assets, like bonds over stocks, investment-grade versus higher yields, or so-called “risk-free” government bonds rather than almost anything else. This is what a flight to safety would look like, and all of it would likely push bond yields back, pushing bond prices higher in the process (and doubling for long bonds, so a recession usually coincides with a risk of deflation).
It’s a bit complicated though and probably hard to hear after a period of falling prices. both stocks and bondsWe remain firmly of the belief that bonds play a much-needed role in risk management, especially in times of market stress.
More twists and turns ahead
Looking at today’s environment, there is a slowdown in the minds of everyone from investors to consumers. However, our analysis shows no imminent bearish setting on the horizon. We believe that risks are rising and an economic downturn is imminent. In our view, the macro recession will continue in the short to medium term as global central banks tighten financing conditions amid high inflation; And the longer inflation remains stubbornly high, the tighter it will become and the more likely we are to slip into a recession.
Consider this week progress as markets look ahead. They appreciate and adapt in advance. In many ways, this week’s plunge into a bear market already reflects many of the economic fears outlined above. And while we’d generally see sell-offs in excess of 20% as opportunities to add, our economic concerns are significant. Consistent with our risk appetite, we remain positioned with a slight defensive bias and have significant dry powder in the portfolio should the market present further attractive buying opportunities. Until then, we will continue to manage risk and opportunity in the midst of a bear market, using all the tools in our toolkit to ensure your portfolio is best positioned for which market and economy.