Are Investors Through the Worst of It Yet?

by Kevin McCreadie, MBA, CFA®, CEO, and Chief Investment Officer, AGF Investments Inc.

Equity markets are rallying again, but more time and more positive data may still be needed to put this year’s bear market behind us for good, says AGF’s CEO and Chief Investment Officer.

Why are equity markets still volatile despite having found some footing in the past few weeks?

The volatility of the past few months is typical of a bear market. While the defining characteristic is a negative return of 20% or more, it is common that stocks rally at certain times through the bottoming process, only to stall like they did in the late summer and may do again if the current rally can’t be sustained. Part of this is just a function of time. Notwithstanding the swift and unprecedented rebound from the pandemic selloff in early 2020, it usually takes several months if not years for equity markets to right themselves completely. For instance, during the Global Financial Crisis, the peak-to-trough drawdown in the S&P 500 Index lasted almost 17 months.

Of course, having said that, this time around may not be so protracted depending on the next moves of the U.S. Federal Reserve and other central banks. Right now, many investors desperately want to believe the Fed is ready to start reducing the magnitude of its interest rate hikes as soon as next month, and the latest inflation print in the U.S. (which fell to 7.7% in October and was lower than expected) has only strengthened this belief. In fact, there’s now an 80% likelihood that the Fed will raise rates by 50 basis points in December, according to CME Fed Watch data, which, if it were to happen, would break a string of four straight 75-basis-point increases that began earlier this year.

Is that enough of a catalyst to put the bear market behind us finally?

It’s a step in the right direction, but investors need to be cautious. Inflation is still running hot by most standards and while the Fed seems set to become less aggressive, it may still be months away from ending its current tightening cycle altogether. As long as central banks continue to raise rates – no matter the degree – there remains a risk that their actions choke economic growth to such an extent that it causes a recession, which, at the least, could result in even more volatility ahead.

What do you expect of markets once this tightening cycle does end?

The next bull market should follow shortly after, if history is any guide, but the macro backdrop to it will be different from what it was the last time stocks rallied for an extended period without a significant correction. Over the past decade and a half, for instance, investors have grown used to the idea of ultra- accommodative monetary policy and non-existent inflation, but that will no longer be the case. Even if the Fed and other central banks end up cutting rates, it seems unlikely they will do so in a manner that brings them back to near zero.

At the same time, inflation may fall from current levels, but not so much that it disappears completely. While reducing inflation from north of 7% to 4% may be relatively easy, going from 4% to 2% – where central banks would like to see it – is likely to be much more difficult, in part because higher prices, to some extent, have now become expected.

If anything, we may end up in an environment like that of the 1990s when short-term rates and inflation ran somewhere in a range of 3% to 4% for a good part of the decade and equity markets did very well indeed.

More importantly, the next bull market may not be led by the same sectors and factors that benefited the most during the era of easy money that began following the Global Financial Crisis. As such, it will be incumbent on investors to figure out which areas of the market stand to benefit most in the new macro environment that is currently unfolding and may be with us for some time to come.

Short of that, volatility should be expected to continue, both in equities and bonds, as markets react to the flow of incoming data over the next few weeks. In particular, “soft” data that suggests central banks will pivot towards a more moderate tightening of monetary policy – including a reduction in the magnitude of their rate hikes or an outright stop to them – will likely be met with relief and a further rally in risk assets.

But if any of the data suggests otherwise, that kind of relief could be short-lived and may culminate in more downside ahead.

Kevin McCreadie is Chief Executive Officer and Chief Investment Officer at AGF Management Limited. He is a regular contributor to AGF Perspectives.

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The views expressed in this blog are those of the authors and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds, or investment strategies.

The commentaries contained herein are provided as a general source of information based on information available as of November 15, 2022 and are not intended to be comprehensive investment advice applicable to the circumstances of the individual. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Market conditions may change and AGF Investments accepts no responsibility for individual investment decisions arising from the use or reliance on the information contained here.

AGF Investments is a group of wholly owned subsidiaries of AGF Management Limited, a Canadian reporting issuer. The subsidiaries included in AGF Investments are AGF Investments Inc. (AGFI), AGF Investments America Inc. (AGFA), AGF Investments LLC (AGFUS) and AGF International Advisors Company Limited (AGFIA). AGFA and AGFUS are registered advisors in the U.S. AGFI is registered as a portfolio manager across Canadian securities commissions. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. The subsidiaries that form AGF Investments manage a variety of mandates comprised of equity, fixed income and balanced assets.

® The “AGF” logo is a registered trademark of AGF Management Limited and used under licence.

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