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Stock Market Drop Accelerated as Recession Seemed More Likely

Investors had an awful start to the year as stocks twice entered bear market territory, falling more than 20 percent. Stocks didn’t hang there long the first time, but the second drop has proved more durable, as Wall Street has come to accept that inflation is more persistent and that the Federal Reserve will have to be more aggressive in combating it.


The S&P 500 lost 16.4 percent in the second quarter, leaving it 20.6 percent below its level at the end of 2021.


Where to now? While a bounce in stocks certainly seems due, investment advisers say a lasting recovery is unlikely for now. They warn that a recession is probably on the way, if it’s not here already, and that valuations remain high, even after the big decline.


“I think we’re in for a lot more pain, probably, in U.S. stocks,” said Meb Faber, chief investment officer of Cambria Investment Management. “Just to get back to historical valuations, we could easily go down a third from here.”


Ella Hoxha, a manager of global bond portfolios for Pictet Asset Management, said expectations still haven’t been adjusted to incorporate the likely risk of a recession. It may seem surprising that a recession could catch Wall Street by surprise when the conversation there is about little else. But until recently, Wall Street played down its chances and talked up the prospects of a soft landing, in which growth slows but the economy avoids major, prolonged disruption.


“The odds of a recession have gone up, but the markets have not fully priced in the recession case yet,” Ms. Hoxha said. “Not only is the Fed having to correct being too dovish last year, it has to unwind its balance sheet” by selling the bonds and other securities it bought to support the economy and markets.


U.S. Treasury yields fell Wednesday, as investors sought shelter from a blistering sell-off in the equities market.


The yield on the benchmark 10-year Treasury note fell 9 basis points to 2.88%, despite topping 3% earlier in the day. The yield on the 30-year Treasury bond traded down 10 basis points to 3.061%. Yields move inversely to prices and 1 basis point is equal to 0.01%.


The Dow Jones Industrial Average and S&P 500 were on track for their biggest daily declines since 2020, after a quarterly report from retailer Target stoked concern of rising inflation biting into corporate profits. The tech-heavy Nasdaq Composite also faltered, dropping 4.7%.


Those declines pushed the Nasdaq deeper into bear market territory. They also put the S&P 500 down more than 17.7% for 2022; the Dow was down 13.3% year to date.


Risk assets like stocks have been under pressure all year as worries over surging inflation and tighter Federal Reserve policy rattled investors. On Tuesday, Fed Chairman Jerome Powell said on Tuesday that the U.S. central bank would continue to raise interest rates until inflation starts to fall back to a healthy level.


Kit Juckes, macro strategist at Societe Generale, said on Wednesday that it’s “not just the rate hikes that hurt” the economy.


“The jump in inflation, increased uncertainty, the way that the huge pile of savings is distributed through society, all challenge the US economy’s resilience,” he explained.


Treasury yields, meanwhile, have been on the rise in 2022. The benchmark 10-year started the year at around 1.5%. However, investors turned to bonds Wednesday in their search for cover from the stock market sell-off.

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