Dual Bond And Stock Market Selloffs Look Likely

Everybody’s talking about higher inflation and rising interest rates, but are they worried? Not really. The Fed’s on the case, so investors are asking, “Which investments are best to buy?”

Barron’s the answer on its January 17 cover (underlining is mine):

“2022 Roundtable – Our experts see a strong economy, a volatile market, and a good time for bargain hunting.“

Turning to the article for stock ideas, we run into a cautious title, “Time to Buckle Up,” based on this summary:

“Wall Street’s pandemic-era party appears to be ending. Stocks, bonds, crypto, you name it – almost every asset class has hit a rough patch since 2022 dawned, and things could get worse before they begin to get better. That’s the consensus of the 10 investors on Barron’s Roundtable, which met this year on Jan. 10, on Zoom. The group looks for inflation to rage and stocks to stumble in the first half of 2022, as the Fed begins to raise interest rates, although the year’s second half could bring more stability and positive returns. Their forecasts for the S&P 500 index range from a double-digit loss for the year to a gain of 8% or so, plus dividends, with most panelists in the middle.”

Obviously, that viewpoint means bargain hunting is more challenging than buying on a dip.

A better conclusion: Don’t bargain hunt because the potential gain doesn’t compensate for the risk

Look at that forecast range: double-digit loss to 8% gain. Why would any investor take on stock risk for that type of uncertain payoff? Moreover, few would arrive at the conclusion that now is “a good time for bargain hunting” when facing six months of inflation raging and stocks [s]tumbling.

The only way to get excited about buying is to take this contrarian view: Because “everyone” sees inflation and interest rates rising, the stock market’s recent weakness has adjusted downward. And that means returns from this point could be better, so now is a good time to buy.

However, there is a serious problem with taking a positive contrarian view

As I explained in “Inflation And Interest Rates Rise – Fed Loses Control,” the size of the Fed’s adjustments are enormous. Moreover, the initial, large moves are reductions of the Fed’s money easing. Tightening won’t begin until the abnormally low interest rates and abnormally large bond purchases have been returned to “normal.” Therefore, there is a long way to go before the Fed is actually fighting inflation.

Also, the Fed has carried out its abnormal money easing actions for fourteen years. Such a lengthy period implants beliefs and attitudes in people, thus making the resulting alternative financial system seem normal. That skewed view applies to professionals as well as individuals. Such firmly held notions make change seem unsettling, dramatic and even wrong. Correcting such views requires sharp, negative moves.

That brings us to…

The flip-side contrarian view: Dual stock and bond bear markets

It’s been forty years since we’ve had that dire environment. When it gets going, the focus on growth evaporates, replaced by expanding visions of weakness.

There are plenty of areas in the current markets that could do with a shakeup – particularly among the hundreds companies that have negative earnings and huge supply of lower credit bonds with inordinately low yields.

However, the real killer of the look-ahead-for-growth attitude is when Wall Street’s analytical process shifts to the short-term and avoiding risk analysis replaces growth story enthusiasm.

The move we are experiencing now may not reach such a negative environment. However, it’s going in that direction, and the conditions are right for its reappearance.