Traders on the floor of the NYSE, June 29, 2022.
A multitude of factors combined to generate the worst first half of the stock market since 1970, but they all emanated from a single word: inflation.
The cost of living started the year at levels the United States had not seen since the early 1980s.
Worse, Federal Reserve officials, armed with annual “transitional” inflation forecasts that now seem almost comically inaccurate, have fallen behind, endangering a market and economy still fragile from the Covid pandemic.
Six months later, the damage has been severe, even catastrophic: an S&P 500 down nearly 20%, a symbol of the collapse of venture investing across the spectrum, from crypto to IPOs and even in certain areas of the commodity market.
“It was inflation. It’s the Fed’s nemesis,” said Quincy Krosby, chief equity strategist for LPL Financial. “It was the Fed that stuck with its ‘transitional’ inflation-calming mindset. … It was central bank largesse, it was government largesse. The Fed was surprise [about inflation] even a few days before its last meeting. That’s how we got here.”
Supply chain constraints that the Fed thought it could ease were driving much of the rise in inflation. Demand simply exceeded shippers’ ability to get produce to market, resulting in much higher prices. Russia’s attack on Ukraine has exacerbated some of these problems, driving up energy and food prices. Buyer confidence plummeted and inflation expectations, among consumers if not in financial markets, surged.
Missed signals, massive damage
After falling behind the inflation curve, the Fed has now been forced to catch up in the form of interest rate hikes worth 1.5 percentage points, with more to come. . Many on Wall Street wondered why the Fed hadn’t been even more aggressive.
Uncertainty over the way forward has compounded the damaging impact of inflation from a Labor Department measure of 8.6%, the highest since December 1981. As recently as December 2021, the The Fed, which is targeting 2% inflation, projected its preferred key measure to turn 2.6% this year; new data on Thursday showed it at 6.3%, with core inflation excluding food and energy even rising to 4.7%.
Fed Chairman Jerome Powell “has to take back control of the inflation narrative…now he’s losing total control,” Allianz economic adviser Mohamed El-Erian told CNBC recently. “He has to move because if he doesn’t, he’s going to chase the market and he won’t make it.”
Along with the damage to major stock market averages such as the S&P 500 and the Dow Jones Industrial Average, which are down more than 14% year-to-date, there has been carnage everywhere.
The more tech-focused Nasdaq suffered losses approaching 30%. Bitcoin, the most prominent cryptocurrency, fell nearly 60%. Copper, often considered an economic indicator, fell more than 15% and cotton more than 13%.
Capital markets also took a beating.
The special-purpose acquisition companies, which provide blank checks to investors and were all the rage last year, have fallen on hard times. CNBC’s Post SPAC index, which tracks vehicles from their initial listing via a merger target or live deal, is having its worst month since its November 2020 listing, down nearly 25%.
Private companies have been slow to come to such a dismal market. IPO volume fell 46% in the first half, with revenue down 58% from the same period a year ago, according to Ernst & Young.
History offers hope
So what will stop the bleeding?
“For the market, the old phrase is the market gets the news first. All the market is waiting for is for the Fed’s rhetoric to soften,” LPL’s Krosby said. “That would cause the market to wait for maybe a break or maybe even [interest rate increases of] 50 basis points or 25 basis points, depending on where we are.”
Markets, however, are expecting another 75 basis point rate hike in July, similar to the one in June. A basis point is one hundredth of 1 percentage point.
About the only things that have worked this year have been certain sectors of commodity markets, such as oil, natural gas and some agricultural products. These gains, however, were offset by huge losses in everything from banks to automakers to building products.
Still, there are reasons for optimism.
When the S&P 500 plunged 21% in the first half of 1970, it quickly reversed those losses to gain 26.5% in the second half and a gain for the year.
“You trade and invest in the markets you have, not the ones you want,” Krosby said. “Can this market recover in the second half? A lot of things have to line up. But it’s happened before.”