NEW YORK, Sept 30 (Reuters) - Investors believe the
feedback loop between U.S. stocks and bonds will likely be a key
factor in determining whether the gyrations that have rocked
markets this year continue into the last months of 2022.
With the third quarter over, both assets have seen painful
sell-offs - the S&P 500 is down nearly 25% year-to-date
and the ICE BofA Treasury Index has fallen by around 13%. The
twin declines are the worst since 1938, according to BoFA Global
Yet many investors say bonds have led the dance, with
soaring yields slamming stock valuations as market participants
recalibrated their portfolios to account for
stronger-than-expected monetary tightening from the Fed.
The S&P 500s forward price-to-earnings ratio fell from
20 in April to its current level of 16.1, a move that came
alongside a 140 basis point surge in the yield on the benchmark
U.S. 10-year Treasury, which moves inversely to
"Interest rates are at the core of every asset in the
universe, and we wont have a positive repricing in equities
until the uncertainty of where the terminal rate will settle is
clear, said Charlie McElligott, managing director of
cross-asset strategy at Nomura.
Volatility in U.S. bonds has erupted in 2022, with this
weeks Treasury yield gyrations taking the ICE BofAML U.S. Bond
Market Option Volatility Estimate Index to its highest
level since March 2020. By contrast, the Cboe Volatility Index
- the so-called Wall Street "fear gauge" - has failed to
scale its peak from earlier this year.
We have emphasized ... that interest rate volatility has
been (and continues to be) the main driver of cross-asset
volatility. Nevertheless, even we continue to watch the rates
volatility complex with incredulity, analysts at Soc Gen wrote.
Many investors believe the wild moves will continue until
there is evidence that the Fed is winning its battle against
inflation, allowing policymakers to eventually end monetary
tightening. For now, more hawkishness is on the menu.
Investors on Friday afternoon were pricing in a 57% chance
that the U.S. central bank hikes rates by 75 basis point rates
at its Nov. 2 meeting, up from a 0% chance one month ago,
according to CME's FedWatch tool. Markets see rates hitting a
peak of 4.5% in July 2023, up from 4% a month ago.
Next weeks U.S. employment data will give investors a
snapshot of whether the Feds rate hikes are starting to dent
growth. Investors are also looking to earnings season, which
starts in October, as they gauge to what degree a strong dollar
and supply chain snafus will affect companies profits.
For now, investor sentiment is largely negative, with cash
levels among fund managers near historic highs as many
increasingly choose to sit out the market swings. Retail
investors sold a net $2.9 billion of equities in the past week,
the second largest outflow since March 2020, data from JPMorgan
showed on Wednesday.
Still, some investors believe a turnaround in stocks and
bonds may soon come into view.
The deep declines in both asset classes make either an
attractive investment given the likelihood of longer-term
returns, said Adam Hetts, global head of portfolio construction
and strategy at Janus Henderson Investors.
"We've been in a world where nothing was working. Most of
that agony is over, we think," he said.
JPMorgans analysts, meanwhile, said high cash allocations
may provide a backstop for both equities and bonds, likely
limiting future downside.
At the same time, the fourth quarter is historically the
best period for returns for major U.S. stock indexes, with the
S&P 500 averaging a 4.2% gain since 1949, according to the Stock
Of course, dip buying has fared poorly this year. The S&P
500 has mounted four rallies of 6% or more this year, with each
rebound sputtering out to be followed by fresh bear market lows.
Wei Li, Chief Investment Strategist at BlackRock Investment
Institute, believes more jumbo rate hikes from the Fed may dent
growth, while a slower pace of tightening could hurt bonds by
making inflation more entrenched.
She is underweight developed market equities and fixed
income, believing that difficult choices faced by central
banks will spur more market ructions.
Equities may have further to fall than bonds given the high
likelihood of a recession in 2023, said Keith Lerner, co-chief
investment officer and chief market strategist at Truist
"We think the upside for equities will be capped because
there will be more earnings pain and more central bank
tightening," he said.
(Reporting by David Randall; Additional reporting by Saqib
Iqbal Ahmed; Editing by Ira Iosebashvili, Jonathan Oatis and