The distinctive feature of the 2022 drawdown is that the typical safe-haven government bonds are falling alongside equities and in the case of long-term Treasuries have experienced an even steeper drawdown, exceeding 22%. Thus far, the only real hedge that has worked well is energy and commodities, but that trade remains high risk given the ongoing war in Ukraine and the potential for a reduction in demand for fossil fuels if economic growth declines. The synchronized decline in both stocks and bonds has certainly made this year’s “average” drawdown seem more painful, with even the most conservative investors experiencing some degree of losses.
2020’s COVID lows should serve as a recent reminder of how quickly markets can shift from despair to exuberance and drawdowns can be erased. Recall the lows of the COVID shutdowns, as investors braced for the unemployment surge and a presumed deluge of corporate defaults. Once this crisis was averted via Federal Reserve and government intervention, the narrative quickly shifted towards vaccinations and reopening, triggering an epic run in the markets. Presently, the market is under pressure because it doubts that the Federal Reserve can successfully engineer a “soft landing” as it combats inflation via interest rate hikes. Inflation data will determine whether this narrative changes in the coming months, and we expect to see lower headline inflation numbers as some of the large inflation spikes from last year drop off the trailing data. Aside from inflation, many economic indicators, particularly employment data, suggest that the economy may be able to weather the rate hike shock without slipping into a recession. If that scenario plays out, expect the market to quickly forget the drawdown, and have less downside and even rally in Q4 after the midterm elections.
