Rarely can we point to one factor driving the performance of all markets. But since the global financial crisis in 2008, that factor is low interest rates. As soon as the Fed and other central banks cut their policy rates to zero and started quantitative easing (QE) in late 2008, it set the stage for one of the largest equity market rallies in history. US stocks rose by almost 400% from late 2008 until the Fed started to hike rates earlier this year (Chart 2). And it was not just equities. Almost every asset market value was inflated – whether bonds, real estate or credit. That is why we call this era the ‘everything bubble’. But the ‘everything bubble’ is clearly bursting.
August was yet another month that demonstrated this. Global equity markets fell 4%, bitcoin fell 16%, US bonds fell 2.5%, and even commodities fell 2.7% (Chart 3). Some markets performed less poorly – EM bonds only fell 0.5%, and EM equities were flat. But the trend is clear, and we see further downside ahead.
Central Banks Will Hike Further
The crux of the matter is that central banks can no longer act to stabilise markets and growth. Inflation is simply too high. The risk is that they hike rates further to levels not seen since before the global financial crisis. That means the Fed could raise rates to 5.25%, the ECB to 4.25%, and the Bank of England to 5.75%.
Such levels may seem high, especially since investors have grown accustomed to zero rates and QE. But these were the levels reached in the 2000s when inflation was lower than today and unemployment was higher. And they are much lower than the levels of the 1970s, which is the closest comparison to today’s supply shock.
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Governments Provide Less Support to Markets
With central banks acting as a brake on asset markets, it will be left to governments to act as a stabiliser. Yet there is no consensus on the right government response to the current macro environment. The latest US action was to forgive student loan debt, the UK is likely to introduce price controls on energy prices (following much of Europe), and China is attempting to revive its housing market.
In our view, all this points to further downside in asset markets. We continue to be overweight cash. This is a defensive posture but also gives us liquidity and the ability to mop up assets when they reach distressed levels. It also prevented us from losing money in August. We stay underweight equities and bonds given our view above. On commodities, we are neutral: supply issues suggest strength, but weaker growth suggests weakness, so these forces offset each other.
Finally, on equity sectors, here are our favourite views: Within US, we like to be overweight energy, large cap value, semiconductors, financials, traditional infrastructure, clean energy, and healthcare. We would underweight homebuilders, large cap growth, consumer discretionary and staples, and technology.
Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.