Anyone watching the market knows that stocks have been hammered since the Federal Reserve started in March, which turned into an aggressive series of interest rate hikes, but Deutsche Bank strategists say they might be surprised to learn that these rate hikes are probably not the culprit.
The S&P 500 SPX,
has experienced a negative return of 16.1%, at its current level, since the start of the rate hikes. It’s the worst performance for an extended cycle of rate hikes since at least the late 1950s, according to a team led by chief strategist Binky Chadha in a Monday note (see chart below).
The chart highlights what may surprise many investors: cycles of rising rates, historically, have not been negative for equities. Of the previous 11 hiking cycles dating back to 1958-59, only two (1994-95 and 1973) produced negative returns. On average, cycles of rising rates have produced a 9% return for the S&P 500.
Any misconceptions that rate hike cycles have tended to be negative for equities were likely reinforced by poor market performance in 2022, but a closer look at the tape shows why that conclusion doesn’t hold. writes Chadha and his team:
Unlike most historical rate hike cycles, which saw a positive correlation between Fed rates and equities (median +61%; 8 out of 10 positive), this cycle was strongly negative (-68%) . This negative correlation naturally suggests that higher rates have driven stocks lower, reinforcing the widely held belief. A closer look, however, reveals that the S&P 500 has been at current levels 4 times in the past 5 months, while rates have been successively and significantly higher each time, with the 2-year yield up 175 points. basis (basis points) since the first time. This contradicts the view that higher rates led to the S&P 500 selling off, or at least shows that the last 175 basis points of rate hikes did not push the S&P 500 lower.
So if sharp interest rate hikes aren’t the driver, what’s behind the selloff?
Deutsche Bank analysts suspect it’s more volatility in the bond market, which has seen a steady rise since the Fed began raising rates. This is unusual, they said, with rate volatility typically peaking near and around the initial Fed hike and around changes in the speed of the hikes over the cycle, then dissipating quickly.
The volatility of Treasury yields, as measured by the ICE BofA MOVE Index, has not tended to increase in a sustained manner during rate hike cycles, they wrote, with the sole exception of the hike cycle. of 1973, which was the only one that also experienced a major stock market sell-off.
Indeed, when rates and rate volatility have diverged in the current cycle, the stock market has inversely tracked the movement in volatility rather than the level of returns, analysts noted. For example, they highlighted June, when volatility rose and stocks fell sharply while yields rose slightly; August, when yield volatility fell even as yields rose; and the recent streak, which saw equities rebound alongside declining return volatility as returns were constrained (see chart below).
“The sell-off in equities during this rate hike cycle has been driven, according to our reading
more by rising rates vol than by higher rates, in what is a strong parallel to the only other rate hike cycle (1973) that had previously seen stocks fall significantly,” the authors wrote. strategists. “Vol” is market shorthand for volatility.
The key question for investors is therefore whether the volatility of returns will decline. Chadha and his team believe this is likely to be the case, for two reasons: a slower and more “deliberate” pace of Fed hikes ahead; and the fact that rates have already risen significantly, bringing them closer to their peak, although they will only get there gradually.
Volatility between asset classes tends to be highly correlated, they said, and driven by a common driver, which in this case has been the result of frequent changes in Fed guidance and the speed of hikes. rate.
This means that a drop in return volatility should lead to a drop in equity market volatility, with systematic strategists ready to increase equity exposure from extremely low levels and signaling that the market rally needs to go further. away, they said.
Stocks were slightly lower in lackluster trading on Tuesday, with the S&P 500 down about 0.4%, while the Dow Jones Industrial Average DJIA,
was down about 60 points, or 0.2%.
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