Same Same, But Different, But Still the Same
At this point, it has become evident that there is nowhere to hide in the market. More specifically, every major asset class is down on the year. US, international, and emerging markets stocks are all down over 25% YTD*. Investment grade domestic and international bonds are down in excess of 15% YTD**. Even vaunted Hedge Fund managers are taking a proverbial bath this year.
The question to ask is not why this is happening; although, I can certainly speak to the various policy mistakes that are driving this downturn – rather, we should look to history to guide our steps going forward. The only other instance since WWII that mirrors our current scenario is The Great Recession of 2008.
Trying to perfectly time shifts between bull and bear markets is bordering on impossible. So, let’s look at a timeline of US market movements in concert with monetary and fiscal policy changes through the 2008 financial crisis.
2007 was chugging along through the end of Q3. All of the major U.S. indices actually hit their respective peaks during October 2007. By this time, the Fed had already been raising rates for a few years, and the terminal rate sat right around 5.25%. About the same time markets were peaking, growth had already been slowing in the United States. Unemployment rates and mortgage defaults were on the rise, and the market barely took notice.
By the end of the year, volatility was showing signs of breaking out and stocks started acting a little nervy. If you remember, this closely resembles what the fall of 2021 looked like from a market volatility perspective. To take this connection a step further, the bear market wasn’t actually called until the end of Q2 in 2008 (also the same time oil prices peaked around $140/barrel). Quick reminder, our current bear market was not declared until June of 2022 (roughly 2 months after oil peaked around $130/barrel). Calling this timeline “similar” would be an understatement.
I digress. After a few minor rallies (bear market bounces), markets tanked following the bankruptcy of Lehman Brothers in September of 2008. At this point, the Fed had already begun cutting rates and the US government was coming up with a way to keep over leveraged banks afloat. This was effectively the beginning of the Modern Monetary Theory era. That is a blog for another day.
While our current scenario does not have an exact match for the Lehman collapse, one could argue that the fiscal policy and regulatory decisions that are driving another 8% inflation print in September, are crazy enough to be perceived as a similar catalyst. You combine this with continued tightening from the Federal Reserve, and you have a really bad end to Q3 2022.
Since the timeline is essentially the same, but with different catalysts, there is no reason to think the rest of the story does not play out in similar fashion. The only difference is the policy makers have not taken notice of a declining economy yet. This is largely due to this being another election year, and the current administration is choosing to ignore the actual issues plaguing the economy – likely because their policies drove us into this situation in the first place.
Given the timeline, it is reasonable to expect policy changes toward the end of the year and in the early spring that no longer pour kerosene on the inflation fire. As unemployment numbers rise, and they will rise, the Fed will likely stop raising interest rates. If these two things happen simultaneously, markets may very well recover like they did from April of 2009 through the end of Q1 2010, nearly doubling and regaining over half of the lost value for the entire recession.
Of course, nothing is ever guaranteed in investing, and history doesn’t always repeat itself; however, markets do have a tendency to act similarly in times of fear and greed. That is probably because market participants are humans, and we have a hard time changing our behavior patterns.
The moral of the story is fairly simple. Nailing the timing on uptrends and downtrends is impossible, but staying the course and being patient generally yields favorable results over time.
*SPX, MSEAFE, MSEM through 09/30/2022
**IGCOB, BBGATR through 09/30/2022
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