With 72% of global stocks and 99% of bonds now trading at a loss,1 just five of the 44 markets I track daily have positive returns: Energy, Utilities, oil, commodities, and the US dollar. Amid such dour returns, five trends have emerged that I think are worth watching as we head into the fourth quarter.
Over the past 20 years, the historical return correlation between stocks and bonds has been, on average, negative 29%.2
But 2022’s calendar year 60-day average (and median) correlation between the S&P 500 Index and the Bloomberg US Aggregate Bond Index is positive for the first time since 2006. Now, in 2006 both stocks and bonds had gains, so the positive correlation wasn’t painful.
But the rolling 60-day correlation between stocks and bonds has been positive for 70 consecutive periods through mid-September. And with rates likely to continue to edge higher due to ongoing hawkish policy from the Federal Reserve (Fed), this positive correlation is likely to persist.
Stocks and Bonds Show Positive Correlation for 70 Consecutive Periods
Implied volatility, measured by the CBOE VIX Index, has remained above long-term averages — averaging 25 this year versus the long-term average of 19.97.3 But that number isn’t extreme. In 2020 for example, the calendar year average approached 30.
Using just the VIX to measure volatility in this environment has its limitations. Analyzing realized volatility by looking at outsized day-over-day changes can better illustrate the current market’s risk regime.
The S&P 500 Index has witnessed returns of more than +/-1% on 49% of the days in 2022, as shown below. This far exceeds the historical calendar year average of 24%. It’s also the third highest figure since 1970 — just narrowly behind the dot-com era (50%) and the Great Financial Crisis (53%).
More frequent outsized moves reflect the market’s internalization of uneven economic data points, shifting hawkish monetary policies, heightened geopolitical tensions, and waning earnings sentiment.
Because these factors likely will persist in the fourth quarter, expect choppy day-over-day returns to continue.
S&P 500 Moved Up or Down by More than 1% on 49% of Days in 2022
On average, this year’s rolling 60-day sector dispersion has been the highest for any calendar year since the GFC — 29.7% versus 30.4%. That’s the third highest ever.
Currently, a strategy that goes long the top three highest-ranked momentum sectors, rebalanced monthly, is outperforming the S&P 500 Index by 13%,4 in part because of the Energy sector’s outsized persistent returns (i.e., dispersion).
As we head into Q4, given double-digit rolling 60-day dispersion figures for the past 35 consecutive periods and ongoing macro and micro noise, this elevated dispersion is likely to continue.
Rolling 60-Day Sector Dispersion at Highest Level Since 2008
The significant and persistent outperformance of US stocks over non-US has plagued those with more balanced geographical equity portfolios.
US stocks have outpaced international developed equities for 52 consecutive rolling 12-month periods — four intervals shy of a record, as shown below. Given that rolling 12-month US stock excess returns is now 13%,5 and the US is once again outperforming this month, a 53rd month is highly likely.
While the duration of US equity outperformance over emerging markets (EM) is not as long, the magnitude of outperformance has been much greater. Over the past 15 periods, the outperformance of US stocks relative to EM has been in the double digits — averaging 15%.
Currently up 4.7% and 4.4% versus international developed and EM exposures,6 the US is poised to register its fifth consecutive calendar year of outperformance versus both markets – matching prior records for each.
US Stocks Outperforming Non-US
As a group, ETFs, mutual funds, and money market funds have experienced net outflows so far this year. This is the first time this has ever happened, as shown below. Measured individually, only ETFs have inflows across all asset classes and in both active and passive funds.
Only ETFs Have Seen Inflows So Far This Year
Outflows from both stock and bond mutual funds are being driven by redemptions from active managers, indicating that active investors continue to swap into indexed ETFs. Also, the redemption in money market funds hasn’t been from prime funds, but from the more conservative taxable government funds.
The Fed’s report on cash balances offers a clue to where that money may have gone. Its most recent report at the end of Q2 shows time deposits and checking account balances had increased significantly.7
So, it seems investors have opted for plain vanilla cash — a stale non-market to marketed asset (i.e., value doesn’t change) that comes with negative real return expectations given elevated inflation.
If markets continue to fall and remain volatile, this limited commitment of capital could continue into Q4. ETFs, however, are likely to remain the sole asset gatherer, as historically their average flows in the fourth quarter have been 160% greater than all other individual quarters averages.8 ETF flows also are likely to reap a tailwind due to poor active manager performance and the tax inefficiency of mutual funds.
These charts highlight the trends that have made 2022 a complex and challenging year, and one that rivals periods more synonymous with systemic risk events like the GFC and dot-com era.
Because the catalysts driving these trends are unlikely to slow during the last quarter of the year, watching them and keeping these charts in mind can help frame your investment discussions and asset allocation decisions.
As a difficult 2022 comes to an end, we’ll continue to offer market insights, including coverage of tax-loss harvesting.
1 Bloomberg Finance, L.P., based on the MSCI ACWI IMI Index and the Bloomberg US Aggregate Bond Index as of September 14, 2022.
2 Bloomberg Finance, L.P., based on the daily returns of the S&P 500 Index and the Bloomberg US Aggregate Bond Index as of September 14, 2022. Correlations from 2002-2022.
3 Bloomberg Finance, L.P., based on the CBOE VIX Index.
4 Bloomberg Finance, L.P. as of September 14, 2022 based on SPDR Americas Research calculations based on the monthly returns of the sectors within the S&P 500 Index using a 12-month, 6-month, and 3-month momentum screen.
5 Bloomberg Finance, L.P., based on the return of the S&P 500 Index and the MSCI EAFE Index.
6 Bloomberg Finance, L.P., based on the return of the S&P 500 Index and the MSCI EM Index.
7 The Fed - Money Stock Measures - H.6 Release - August 23, 2022 (federalreserve.gov).
8 Bloomberg Finance, L.P., based on SPDR Americas Research calculations.
Bloomberg US Aggregate Bond Index
The Bloomberg US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate pass-throughs), ABS and CMBS (agency and non-agency).
CBOE VIX Index
The VIX Index is a financial benchmark designed to be an up-to-the-minute market estimate of the expected volatility of the S&P 500® Index, and is calculated by using the midpoint of real-time S&P 500 Index (SPX) option bid/ask quotes.
MSCI ACWI IMI Index
The MSCI ACWI Investable Market Index (IMI) captures large, mid and small cap representation across 23 Developed Markets (DM) and 23 Emerging Markets (EM) countries
MSCI EAFE Index
The MSCI EAFE Index is a free-float weighted equity index. The MSCI EAFE region covers DM countries in Europe, Australasia, Israel, and the Far East.
MSCI EM Index
The MSCI EM (Emerging Markets) Index is a free-float weighted equity index that captures large and mid-cap representation across Emerging Markets (EM) countries. The index covers approximately 85% of the free float-adjusted market capitalization in each country.
S&P 500 Index
The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.
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