(Bloomberg) — The feel-good days for global markets at the end of March are firmly over.
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Everything from stocks to bonds is falling — even oil has pulled back from near records — in a concerted cross-asset selloff with echoes of the rate-spurred rout of October 2018.
Blame it on a Federal Reserve intent on restricting policy to tamp down the worst inflation in four decades, even if that threatens economic growth. Unlike four years ago, when Chair Jerome Powell faced market upheaval that would eventually force him to reverse policy, investors in recent weeks have been subject to one Fed official after another pledging higher and higher rates.
With monetary support rapidly receding and recession risks rising, investors are hunkering down. Companies resilient to an economic slowdown such as health care are back in favor. Ditto cash and dividend-paying stocks. Meanwhile, demand for hedging is creeping up in the options market.
“The common denominator in each case is the fear of recession, which has superseded the textbook effect of rising interest rates,” said Robert DeLucia, senior economic adviser at Empower, a retirement services company. “We are seeing a stampede into defensive stocks and an aversion to economically sensitive stocks.”
More than a week into April, soap manufacturers, drugmakers and utilities are dominating the list of winners among S&P 500 industries. At the bottom are chip producers and shipping companies — firms whose profit outlook is closely tied to the economy. All told, the world’s most watched benchmark index is down 2.6% this month, including a 1.7% drop Monday.
Emerging markets are nursing losses too, with indexes tracking stocks and bonds in the asset class falling 2.6% and 1.4%, respectively.
With the Fed mired in what’s expected to be the most aggressive tightening cycle since 1994, the drumbeat of recession warnings is getting louder. In a report earlier this month, Deutsche Bank AG strategists Binky Chadha and Parag Thatte said they anticipate the S&P 500 to drop 20% from peak to trough in late 2023, coinciding with an economic retrenchment.
All the same, evidence of a growth contraction is scant right now. The labor market is booming, consumer finance looks healthy and corporate plans on capital spending remains robust. So whether the latest flight to safety stocks reflects a growth scare or a valuation scare is up for debate. But what’s certain is the fact that the Fed’s hawkishness still has the capacity to shock markets.
Underpinning the recent rout were the disclosures from the Fed that balance-sheet shrinkage would begin sooner and unfold more quickly than some market participants expected. The message, first sent by Fed Governor Lael Brainard last Tuesday, got reinforced in the minutes of the March Federal Open Market Committee meeting the following day.
Treasuries sold off, with the 10-year yield climbing through 2.75% and inflation-adjusted rates edging ever higher. A Bloomberg index tracking government bonds is down almost 2% in April, on course for its fifth straight monthly decline, the longest since 2016.
Indexes tracking investment-grade bonds and high-yield credit have also fallen. Should stocks, bonds and oil end April lower, that would be the first time since 2018 that all major assets suffer losses.
“Just two weeks ago Mr. Market was pricing a cyclical overheating story that the Fed would address while the longer-term growth and inflation expectations stayed the same,” said Dennis DeBusschere, the founder of 22V Research. “Brainard blew up the argument that Fed is unwilling to accept the risk of slowing inflation quickly, and markets reacted appropriately.”
With sovereign bonds falling out of favor, a cohort of investors is seeking shelter in cash. In Bank of America Corp.’s March survey of money managers, cash holdings rose to the highest since April 2020.
Traders are also reloading protections in the options market after cutting their hedges during the March rebound. The Cboe Volatility Index, a gauge of prices on S&P 500 options, has risen 3.62 points this month to 24.18, closing a rare discount over the 30-day realized volatility in the underlying benchmark. Meanwhile, the 20-day average of Cboe’s put-call volume ratio for single stocks rose from a four-month low.
“Don’t fight the Fed when the Fed is fighting inflation,” said Ed Yardeni, the president of Yardeni Research Inc. “The war in Ukraine has heightened the odds of higher-for-longer inflation, tighter-for-longer monetary policy, and recession in the U.S. and Europe.”
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