The Sell-Off Continues
by Zach Marsh on May 20, 2022
US equity indices, as of 10am, seem nearly certain to log another down week. Absent a dramatic turnaround this afternoon, this down week will mark the 7th consecutive losing week for the large-cap index. Year-to-date the S&P 500 now sits nearly 18.5% below its all-time closing high set on January 3rd of this year. The tech-heavy Nasdaq 100 and the small-cap Russell 2000 are both down roughly 30% from their all-time highs. In the indexed equity space, no place has been safe this year. More problematic for diversified investment portfolios has been the corresponding poor performance of bonds at precisely the time their good performance is needed. Since mid-December, TLT iShares 20+ year US government bond ETF, is down 23.5%. While gold, a desired safe-haven investment choice, is only moderately higher since the beginning of the year.
From the beginning of this brutal sell-off in stocks through last week, the correlation between stocks and government bond prices have been significantly positive, meaning that the prices are going down in tandem. However, if we are searching for silver linings, we may have found one this week as the positive correlation between stocks and bonds seems to have broken. At the current time, the S&P 500 is down 3.8% for the week and long-term Treasury bonds are up nearly 2%. At the same time gold, measured by the gold ETF GLD, is up 1.97% as well. The pain of equity bear markets become slightly more tenable when other investment options are providing shelter from the storm.
Since my last letter two weeks ago, the government released yet another CPI report that showed inflation continues to grow at a rapid pace. In response to that report the Fed has made it clear that its number one priority is bringing that number down hard and fast. In the past the Fed has shown weak resolve to raise interest rates when the major stock indices have fallen more than 10% from their highs. This lack of resolve has often been referred to as “The Fed put,” borrowing language from options describing an instrument which can protect or limit an investors downside risk. The idea being that once a pain threshold has been reached in the market the Fed will step in with either asset purchases or more accommodating interest rate policy. The “put,” however, no longer seems to exist as the Fed’s policy mandate has shifted dramatically in the face of runaway inflationary risk. It is possible that, for the first time in nearly 30 years, the market can no longer rely on the Fed to stop the bleeding. Much of this remains to be seen, as betting against a 30-year behavior pattern is not normally a good bet. Yet we have also not seen inflation readings like we have now in over 40 years.
Awhile back I discussed in one of these notes how far above long-term averages current S&P 500 prices were. When the S&P 500 made its high on January 3rd, its closing price was more than 30% higher than its 200-week moving average. Since that time the 200-week moving average has risen 6%, from 3320 to 3500, while the price has declined from 4780 to 3860, narrowing the distance between the price and long-run average to roughly 10%. Going back to 1970, the 200-week moving average has been pretty reliable support for the S&P 500, when the long-term bull market remains in effect. Only during periods of significant bear markets does the S&P 500 trade below the 200-week moving average for extended periods of time. In fact, since 1970, there have only been 3 times when the S&P 500 traded below its 200-week average for a substantive amount of time. From 1973-1975 the S&P traded below its 200-week average, reaching a low price that was of 38% below the average. Again, during the tech-bubble bursting, the S&P reached a low that was 36% below the average. Finally, in 2009, the S&P 500 reached depths of 47% below the 200-week average.
There is a lot of game remaining to be played before we know whether the average will hold the downturn in stocks. Most up days in the market are now viewed as temporary bear market rallies that will retrace in short order. In the meantime, we can perhaps look to alternatives to equities to start doing more of their share of the heavy lifting to stabilize diversified portfolio allocations.
Thanks for reading,
Zach and Dave
