Remember the Great Recession of 2008-09? Along with the evaporation of investment banks and the deeds to homes of thousands of Americans, this unfortunate economic phenomenon also affected the S&P 500. It was a one-two punch for S&P 500 that led to interests falling, and the Federal Reserve buying mortgage-backed securities. The Fed even helped bolster the bond market as well, which caused a constant decline for rates. The only place to go was the equities. Bonds were seen as stocks, and investors gave up on yield. They rather hoped that bonds priced at 110 would hit 120. This was the Great Recession 8 years ago – everything was sky high.
Since 2011, we have been experiencing a raging bull market. For 7 years, the US stock market only had one major correction, which was a 19% drop.
However, once the central banks abandon QE, and the interest rates normalize to the point the equity market steps back to pre-QE levels, you would likely think S&P 500 gets around 1500 points.
Before the Great Recession, the previous bear market happened after the dot-com bubble burst and the planes piloted by terrorists crashed into the Twin Towers in lower Manhattan on Sept. 11, 2001. Shortly, the S&P 500 dropped 49% from a high ground of about 1510. After 6 years, it fell again to 666 in Intraday trading on March 6, 2009. It has been the lowest S&P 500 hit since 1996.
We could trace the slide that took place on the second week of February to the U.S. non-farm payroll report for January, which showed an increase in average earnings growth to 2.9%.
Wage inflation scared the bond markets. The expected inflation resulted in pricing in a 0.75% rate hike, then came a prospective hike for the fourth time.
“Powell Put” which thought to be less market-friendlier than “Greenspan-Bernanke-Yellen Put,” helped equity levels reach record levels, and inflated the financial asset prices.
ETNs, exchange-traded notes was revealed. These strategies of betting on low equity volatility caused the aggravation of inflation concerns. According to BlackRock’s chief investment strategist Richard Turnill, the retreat was somehow caused by the rapid run-up in government bond yields. However, investors who prefer to remain active just had to focus on the fundamentals of the economy. But the fundamentals are still changing, says Turnill.
On the second week of February, the US congress approved a budget deal that expands the government’s spending for defense by about $300 billion over two years. This approved bill and tax cuts will stretch out the federal deficit further.
“We could see net Treasury coupon issuance more than doubling this year,” he says.
That’s not good for the US Treasury bonds. The equity market is smaller than the bond market.
Turnill says, the combination of the government spending and corporate tax cuts can result in the addition of roughly 1% to GDP this year, in comparison to the 0.8 percentage point in the last report.
A strong economy can easily raise inflation, and allow the Fed to increase interest hikes faster. Along with that, the central banks will loosen up their QE programs that could drive the S&P absolutely lower than it is today. Only if the bears get what they deserve.
