An Orderly Q: Are Investors Panicking?
Inflation retains its ability to surprise investors, but perhaps it is losing its power to shock them. The market consensus on the morning of 13 September had been that the August core year-on-year CPI reading would decelerate from 8.5% the month before to 8.1%. When it came in at 8.3%, equities and bonds dropped on the presumption that monetary policy would have to tighten faster. The S&P 500 Index endured its worst single day since June 2020, falling by 4.3%.1
Yet while this may have felt like a rout, other indicators suggest the reaction was in fact an orderly selloff rather than a panicked capitulation. First, the VIX Index did not spike; it kept well below the elevated levels witnessed both earlier this year and during the hiking anxiety of 2018 (Figure 1). Second, large-caps and smaller companies traded broadly in line, as tracked by the S&P 500 and Russell 2000 (Figure 2). The Russell 2000 even outperformed over subsequent days. This is very different from a disorderly flight from risk, as illustrated by the 2020 crash when a gap of 10 percentage points opened between larger and smaller stocks (Figure 3).
The relative calm in liquid markets was also evident in other gauges. For example, M&A spreads did widen after the CPI print, but did not reach the higher levels experienced earlier in the year. Similarly, convertible bond valuations – which cheapened in the first half – have held up. Overall, we are not seeing extreme stress in markets.
Figure 1. S&P 500 Index and VIX Index
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Source: Bloomberg; as of 22 September 2022
Figure 2. S&P 500 and Russell 2000 After August CPI Release
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Source: Bloomberg; as of 22 September 2022. Rebased to 100 as at 12 September 2022.
Figure 3. S&P 500 and Russell 2000 Selloff in 2020
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Source: Bloomberg; as of 22 September 2022. Rebased to 100 as at 17 February 2020.
Material Concerns About Inflation
The latest CPI numbers also provided an interesting case study in the sensitivity of different equity sectors to inflation and interest rates. Having been clustered before the release, the sectors then dispersed widely (Figure 4).
Some of the reaction was intuitive: utilities and consumer staples were relatively resilient, as would be expected, while materials were harder hit. Consumer discretionary fared poorly in the immediate aftermath, but recovered the following day.
There were also intriguing contrasts with a separate European recession scenario exercise we recently ran. This analysis predicted that utilities and consumer staples would outperform the index in those circumstances, but that energy (which topped the post-CPI table) would struggle amid declining demand and economic growth. Inflationary and recessionary regimes have different sectoral implications; if they coincide, the dynamics of these relationships are likely to be worth monitoring.
Figure 4. Impact of CPI Release on US Equity Sectors
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Source: Bloomberg; as of 22 September 2022. Rebased to 100 as at 12 September 2022.
It’s a Trend World and We’re Just Living In It
We have highlighted before that trend-following strategies have enjoyed a strong 2022 so far, a topic we explore in a new podcast series. Yet the strength of the major market trends is not a recent phenomenon; many asset classes began their current trajectory a year or more ago, rather than hitting an inflection point during the volatility of the first half (Figure 5).
There is some variation among the trends, however: bitcoin has moved sideways over the past few months, and gold changed direction sharply in March but now seems in a more determined trend. Allocators expecting any kind of mean reversion or other reversal may wish to bear in mind that these powerful trends may not be broken without a significant shift in the prevailing macroeconomic environment.
Figure 5. Trends Across Major Markets
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Source: Bloomberg; as of 22 September 2022. All charts rebased to 100 as at 22 September 2021.
With contribution from Gilles Gharios (Head of Investment Risk – Man GLG)
1. Source: Bloomberg; as of 13 September 2022.
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