05.18.2022: Faced with multi-decade record inflation pressure and a hawkish central bank, equity markets are off to their worst start since the pandemic, and among the worst starts to the year in decades. Remarkably, though, equity investors aren’t selling. Holders of SPY, a $365 billion S&P 500 exchange-traded fund, have added roughly 70,000 net new shares to their holdings this year, suggesting equity investors are maintaining their positions even as US large caps face down a bear market. While we could blame imbedded gains and equity holders’ reluctance to pay capital gains tax as one of the reasons for the intransigence, another explanation could be the absence of safe-haven alternatives. In a market where real rates are on the rise, there are few places to hide. Many of the traditional ports in market storms are themselves bobbing in the waves this year.
Cash is trash when inflation costs are rising much faster than yields. While yields on cash have ratcheted higher this year as the Fed has raised the overnight rate, at just under one per cent it remains more than seven percentage points lower than the inflation rate. That means cash hoarders are losing purchasing power every month prices rise even fractionally. Eventually, overnight rates will close in on the inflation rate, but nowadays the gap remains excessively wide.
Et tu, bonds? Bonds, equity holders’ risk-offsetting companion, have lost their luster this year, with the asset class suffering its worst rout in decades. Historically, yields fall in periods of stress and uncertainty, providing a cushion for economically sensitive equities. The S&P lost money over five calendar years between 1977 and 2021, and bonds gained ground in each of those years. Not so far this year, however. Like a ship captain who jumps overboard at the first sign of trouble, the broad bond market index likewise hasn’t held up, and about 10 per cent of its value has been erased so far this year. That’s because the bonds were the bubble, thanks to trillions of dollars of central bank bond buying over the last decade. Now the Federal Reserve and other central banks will be unwinding their purchases.
Gold’s luster is somewhat tarnished this year. Investors continually debate whether gold is a safe haven or a risk asset. As a store of value, gold does a good job keeping pace with inflation over long time horizons. Gold has also held its own during periods of market stress. Lately, gold has been clearly outperforming equities, but it has just slipped into the red for the year. Investors prefer safe-haven assets with low, or negative, correlations to the broad equity market, relying on gold to zig when equities zag. This year, though, the correlation between stocks and the precious metal is approaching one, suggesting they’re dancing in sync.
Bitcoin, which in theory is a digital security blanket, is in reality all wet this year. Crypto was hailed as a digital alternative to fiat currency, a store of value and a safe-haven asset in the event of a financial collapse. Whatever investors had hoped cryptocurrencies would be has certainly not been delivered so far this year. BTC, the crypto bellwether, has lost more than one-third of its value this year and is off nearly 60 per cent since November.
In a market where there aren’t many places to hide, perhaps it shouldn’t surprise anyone that equity investors are standing pat. Given market action this week, perhaps it’s a smart strategy.