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Stock market struggles to reprice risks that credit traders saw in September

‘The ultimate question was, who was right’ — credit or equity markets?
Image: Yuki Iwamura/AFP/Getty Images

The big up-and-down swings lashing equity indexes of late are being driven by stock investors rushing to adjust for risks that the corporate bond market sussed out months ago.

That’s the view of Mike Lewis, head of US equity cash trading at Barclays Plc, who attributes the sudden runup in share volatility to equity traders finally coming to terms with the end of free-flowing stimulus from the Federal Reserve. It’s something credit markets started to take into account in September, suggesting the process has further to run elsewhere.

Divergent signals have ricocheted around markets throughout 2021 as investors tried to get a handle on the post-Covid economy. Buoyant stock investors, fueled by Fed largesse, repeatedly pushed benchmarks to record highs, while their inflation-obsessed fixed-income brethren saw many more reasons for pessimism.

“The ultimate question was, who was right — credit or equity markets? It now appears that credit markets were more in-tune with reality,” Lewis said by phone. “While the Fed was saying ‘no — we won’t have to hike,’ and equity markets were making all-time highs, the credit markets were saying ‘yeah, you will.”

Share gauges are churning through their worst stretch of volatility in a year after Fed Chairman Jerome Powell abandoned his view that inflation is transitory and raised the possibility of ending asset purchases earlier than scheduled. Concern about the new coronavirus variant is also contributing to the unease, which has sent the S&P 500 up or down by more than 1% on five straight days, something that hasn’t happened since November of last year.

While stocks are newly turbulent, credit markets have been signaling trouble for months. In September, high-yield debt as tracked by iShares iBoxx High Yield Corporate Bond ETF (ticker HYG) posted its worst return in a year. It fell in October and November, too, and while up in Thursday’s session, it has fallen in nine of the past 11 days.

“We do believe that the long period in which liquidity ‘lifts all ships’ is coming to an end,” Michael Shaoul, chief executive officer at Marketfield Asset Management LLC, wrote in a note to clients. “Earnings and valuations may start to matter much more in 2022 than they have over the majority of the current year and many of those that have preceded it.”

Stocks climbed Thursday as dip buyers rushed in to scoop up some of the hardest-hit shares. All 11 major industries advanced, lifting the S&P 500 1.4%, the best gain since October.

To Lewis, with the Fed in the process of ceding its role as the bull market’s biggest ally at the same time a new Covid-19 strain takes hold, it’s too early to call all clear.

“Bounces such as we saw today don’t occur because investors all of the sudden are thinking, ‘wow, I really love equities.’ This bounce is due to the outsized selling and sell-pressure being completed from yesterday,” he said. “So when the dust settles, folks will still have a lack of certainty, given the narrative shift at the Fed. Neither investors nor markets like uncertainty, and I’d anticipate more selling until we get clarity” after the Federal Open Market Committee meeting.

© 2021 Bloomberg

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