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August: Worst Cross Asset Selloff Since 1981
From stocks to bonds and commodities, every major asset class slid in the worst broad-based sell off in four decades. Rarely has advice not to fight the Fed borne out more severely. The last time the best-performing asset did worse in a month was December 1981.
"The only way to make money in an absolute sense is cash or shorting something," said James Athey, investment director at Aberdeen Asset Management. "The forward growth outlook is deteriorating. Risk assets are still nowhere near appropriately priced for such an environment and I expect weakness to continue." It's a payback from the summer rally where hopes for a friendly central bank helped add roughly $4 trillion to equity and bond values in July. With Fed Chair Powell pushing back on a pivot and stressing the need to fight inflation even at the expense of growth, bulls suffocated.
As dreadful as things look, American assets are still viewed as a better alternative than the rest of the world, as evidenced by the dollar's advance against a basket of currencies. But viewed as a whole, this month was a futile one for anyone seeking shelter during the global storm. Every global market is being driven the path of Fed policy and its impact on the economy. Linkage among assets has strengthened, forcing every investor to become macro aware. A measure of cross-asset correlation tracked by Barclays Plc sat near the highest levels of the past 17 years, meaning diversification isn't doing what it was intended to do. There is "no place to hide, with fears of tightening liquidity driving a surge in cross-asset correlation," said Emmanuel Cau, head of European equity strategy at Barclays.
Stocks retreated in August with the S&P 500's failure to break above its 200-day moving average emboldened bears, but it was Powell's remarks at the Kansas City Fed's annual policy forum that sent equity bulls scrambling for cover. Bringing down prices, "is likely to require a sustained period of below-trend growth" and an increase in unemployment, the Fed chair said.
While bond traders had anticipated a hawkish message from Powell, the clearly stern tone caught many off guard. Yields on two-year Treasuries spiked to the highest level since 2007 and expectations for additional rate hikes by December grew from what was priced in before the speech.
Synchronized stock and bond selloffs have become a signature feature of 2022. What stands out in the latest bout of selling is the addition of commodities, the darling of the inflation trade earlier this year along with safe haven treasuries, there again has been nowhere to hide.
With the Fed laser-focused in taming price growth, oil posted its biggest monthly drop since November, while gold fell for a fifth straight month, the longest losing streak in four years. All the beating has translated into a tightening of financial conditions, something that Fed policy makers are likely to find comfort with as they seek to raise interest rates and lower asset prices to temper overheated demand.
Angst among equity investors is running high ahead of a slew of market events, including Friday's employment report and the last reading on inflation before the Fed's next policy meeting. Traders are roughly split on whether the central bank will raise rates by a half a percentage point or three-quarters of one. Mutual funds have raised their cash holdings at the fastest rate since the global financial crisis, while equity exposure among hedge funds hovers near a two-year low, data compiled by Goldman Sachs.
In my opinion the only certainty investors have for the next six to 12 months is that global central banks will be simultaneously tightening monetary policy through interest rate hikes and quantitative tightening, I will be looking for meaningful catalysts to buy financial assets upon valuations resets and as clarity emerges with dislocations and inefficiencies between asset classes that take place in markets like this.
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