Historic sell-off in bonds shows how the investor mood has darkened

The five stages of grief are denial, anger, bargaining, depression and acceptance. For investors, the five stages of a bear market appear broadly similar.

Bargaining came over the summer, when investors briefly took seriously the notion that central bankers might be gentle with rate rises, or even reverse them. Now we are stuck somewhere between stages four and five.

This week has demonstrated, as if it were not already obvious, that declines in asset market valuations are simply not going away. In an extraordinary sweep, central banks from the US to Switzerland embarked on what looked like competitive policy tightening.

Fred Ducrozet at Pictet Wealth Management totted up the numbers and found that 10 central banks delivered a massive combined total of 6 percentage points of rate rises just this week. Several rises, including the latest from the US, were of some 0.75 percentage points, three times the usual scale of rate moves. As Pimco economist Tiffany Wilding put it, “75 is the new 25”. 

Doing the most damage, for equity investors at least, the US Federal Reserve has turned up the volume on its warnings on just how much further it is prepared to go. No more sugar coating — Fed chair Jay Powell was clear that further rate rises are coming and that they will involve “pain”. He was referring mostly to pain in labour markets but the same is true of your rapidly shrinking equities portfolio.

Stock markets got the message. The US S&P 500 fell by 1.7 per cent on Wednesday after Powell’s speech, taking losses for the year to more than 20 per cent. 

But still, it looks like investors are clinging on to some key bets. This is getting dicey. As Bank of America notes, the drop in government bonds stemming from sky-high inflation and aggressively hawkish central banks is now in truly historic territory.

Looking at data stretching as far back as 1790 (not a typo — banks just love super long-term data for moments like these), BofA describes this as the third Great Bond Bear Market. We have seen nothing like it since at least the Marshall Plan in 1949, wrote Michael Hartnett and colleagues at the bank. 

That is striking in itself but it matters well beyond the bond market, because the crash “threatens credit events and the liquidation of the world’s most crowded trades”, they said, including US tech stocks, which of course have an outsized impact on US and global stock market shifts. “True capitulation is when investors sell what they love and own,” they added. This axiom has been worth repeating several times this year, and this week is no exception. Investors still have scope to throw in the towel.

So, should you? It is tempting, but investors need to be wary of making bad decisions under pressure. 

Sharmin Mossavar-Rahmani, chief investment officer for wealth management at Goldman Sachs, advises patience. “Stay invested,” she says. A recession in the US is at least partly priced in, she says, and the relentless rise in the dollar will help to tame the Fed’s inflation problem. “When equities have already suffered a significant drawdown prior to the onset of a recession — as is the case today — history suggests investors are better off staying the course,” she says.

It makes sense. But staying the course will demand that investors move on to stage five in their healing process, and accept that a rapid ascent back to recent highs is painfully unlikely. The good old days are not coming back.

For now, the mood remains almost universally glum but, in equities at least, not panicky. “We are feeling ever more miserable with such a gloomy outlook,” says Max Kettner, a multi-asset analyst at HSBC. Eternal optimists will say such consensus glumness is a reason to buy. Maybe. But Kettner adds: “We see a combination of lose-lose scenarios for the next few months.” Either the global economy does OK, in which case, central banks keep on jacking up rates, and sensitive assets like equities drop, or the economy tanks, in which case, equities fall anyway. 

Famed investor Stanley Druckenmiller, once second-in-command to George Soros at the Quantum Fund, sounds further along in the process than many others. “I’ve had a bearish bias for 45 years. I like darkness,” he said in conversation with Palantir chief executive Alex Karp earlier this month. 

The bull market that marked much of that time went into “hyperdrive” in the past 10 years since the financial crisis, and now all the factors that supported it — globalisation, geopolitics, and the resulting low inflation that facilitated ever-easier monetary policy — have gone in to reverse, he said. Now, he said, central bankers “are like reformed smokers. They are not only taking their foot off the gas but slamming the brakes on.”

The result: “There’s a high probability that the market at best is going to be flat for 10 years.”

If he is right, that is potentially bad news for people whose job it is to try to write interesting things about markets on a weekly basis for national newspapers, for example. It will also require a reset of expectations among investors of all types. 

katie.martin@ft.com