Over the last couple of trading sessions, the market has dropped by more than 10% to firmly enter bear market territory. In many stocks and sectors, the entire advance off the March 2020 bottom has been negated.
So far, 2022 has been a tough year for investors that will certainly be discussed in history books. Losing years for stocks is not a big deal, but it's a big deal when both stocks and bonds are lower.
This unusual development is due to the unique economic and monetary conditions. In some ways, it's an inverse of what investors experienced in 2020 and much of 2021 when the Fed was stimulating the economy regardless of inflation or economic growth. Good news was good, and bad news was good.
Environments with weak bonds and stocks increase the likelihood of a market crash or major cascade lower.
We are in a situation where the Fed is determined to bring down inflation even if it causes economic and financial pain. In fact, it could be argued (as former NY Fed Chair Bill Dudley did in a Bloomberg op-ed) that the Fed wasn't doing enough in the battle against inflation if there wasn't sufficient economic and financial pain.
Now, the Fed is certainly achieving this goal. What started out as selling in primarily risk assets is now broadening out. We're also starting to see an economic impact as many industries are dealing with a recession or a slowdown in growth.
Inflation remains high, but it should move lower based on leading indicators like breakevens or monetary stock. Further, less speculation and risk activity is also supportive of inflation coming down in the future.
But, the market is always focused more on the rate of change. And, recent high inflation readings make it clear that the rate of change of inflation coming down is going to be quite slow. In the meanwhile, policymakers no longer can take a 'wait and see' approach. Therefore, a more aggressive policy is going to be necessary to bring down inflation to a more reasonable level.
The market pricing in a more aggressive Fed with even sharper hikes in the coming months is the major reason for the stock market's big decline below 3,800.