Market mayhem isn’t over, catch a falling knife and you’ll get cut

Suddenly after making sense seemingly forever – well, ever since central banks cut rates close to zero in the noughties and starting printing trillions of euros, dollars and yen in new money – the ‘TINA’ stock market trade (there is no alternative) has blown up in what Bloomberg says is an $11trn wipeout across the globe.

You might be forgiven for wondering whether the stock market boom was ever anything more than an overhyped Reddit meme, no different in many ways from those in the now-imploding cryptoverse.

A world in which the FAANG stocks – Meta (formerly Facebook), Amazon, Apple, Netflix, and Alphabet (formerly Google) – deliver endless growth and earnings is well and truly over. Instead of leading markets higher for longer on the prospect of ever fatter earnings, they have to contend with rising interest rates and a newly determined Federal Reserve.

From the start of the pandemic to March 2, 2020 these stocks added a stunning $3.2trn in market capitalisation, according to calculations by Merrill Lynch. That all came to a juddering halt as investors finally woke up to the prospect of a prolonged rate hike cycle to combat inflation.

Meta’s Facebook lost half a million users in the last three months of last year, its first fall in 18 years.

Coming off the Covid-driven surge of the past two years, Amazon’s first quarter revenues increased by just 7pc, down from the heady 44pc expansion in the year-ago period. And it was running the slowest pace of gains in any quarter of the past 20 years.

So there really is a feeling of change in the air for the companies that have led stock markets higher in the past two decades. The FAANGs for the new era are, according to Merrill, fuels, agriculture, aerospace and defence, nuclear, renewables and gold, metals and minerals.

It doesn’t trip off the tongue in quite the same way, but you get the idea.

“Some areas that experienced extraordinary returns over recent years are most vulnerable to higher inflation and rising interest rates as seen by the severe bear market in long-duration growth stocks,” the investment bank said in a recent report.

“Our version of FAANG 2.0 reflects a new world of geopolitical risks and resource/hard asset intensity and is defined by rotations toward these areas.”

While commodities and commodity-related stocks will provide a better hedge against inflation than, say, bonds, it is still a portfolio that is leveraged to growth – and that is in short supply at the moment with the US and European economies already stalling and China running on empty.

In other words, we seem to be entering a very different economic cycle and one in which for most of the world, government spending is falling dramatically and interest rates are on the rise. At the same time, that engine of global growth, the US consumer, is now seeing earnings gains running below trend for the first time since the pandemic hit.

“This means that it generally makes sense to be short the economic cycle in everything from commodity space to equity space. We have started seeing industrial metals rolling over, which rhymes with the lack of economic activity in China and the slowing demand in the west,” says independent market strategist Andreas Steno Larsen.

And this all before we have seen the bulk of central bank tightening. While the Fed under Jerome Powell did deliver its biggest single rate rise in 20 years with 50 basis points at its last meeting, there’s another 150 already locked and loaded for its next three meetings.

The ECB so far has just talked about rate rises, but it is expected to deliver 75 basis of hikes before the turn of the year, pushing its key rate into positive territory.

The outlook for shares and bonds very much depends on whether you think the inflationary pressures are going to decrease from now on. To some extent, time will take care of the headline numbers as those ultra-low pandemic era readings drop out of the year-ago comparisons.

At the same time however, at least in the US, inflationary pressures are moving into stickier services categories – health, education –  from the durable goods impact we saw after the pandemic.

Given that Fed rate rises usually end in tears and that it is not only raising its benchmark interest rates but also tightening policy by starting to sell down its $9trn balance sheet, there is a lot of room for things to go badly wrong.

Even if the Fed does manage perfection, it is going to be some time before market risks abate, according to Capital Economics. 

“This time around, we envisage the Fed’s tightening cycle lasting until around summer of next year. The upshot is that we don’t expect 10-year Treasuries to perform well in the initial 12 months after inflation peaks, assuming it has just done so: our forecast is that their yield will top out at 3.75pc in mid-2023.”

Yields have moved to a tad under 3pc recently after hitting a three-and-a-half year high of 3.17pc in early May.

As for equity markets, it sees the trough for the S&P 500 at 3,750, in mid-2023 and perhaps a loss of six percent doesn’t look so bad after the bloodbath of the past few months.

But that assumes that Mr Powell does indeed have things under control and we get a Goldilocks scenario and not recession, or stagnation.