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October Selloff Leaves Few Places to Hide

Mohamed A. El-Erian
·5 min read

(Bloomberg Opinion) -- That October proved tough for stocks won’t come as a surprise to seasoned investors who still remember some quite challenging months in the past. What is notable this time around, however, is that investments meant to mitigate risks and offset some of the declines from equities also lost money. Understanding why illustrates some of the difficult challenges facing investors in a market greatly distorted by prolonged central bank intervention, and now dealing with weakening economic fundamentals and delayed fiscal policy support.

Let us start with the numbers. For a second consecutive month, the S&P 500 Index declined, dropping 2.8% in October and, in the process, largely erasing most of its gains for the year. The Dow’s 4.6% monthly loss took its year-to date decline to 7%. Even the Nasdaq Composite Index, the persistent out-performer among the three, lost 2.3% and saw its gains for the year reduced to a still respectable 22%. Meanwhile, the bear steeping of the yield curve for U.S. government bonds translated into losses for most risk-mitigating fixed-income exposures. As for gold — an alternative allocation that has gained greater popularity recently — it wasn’t much help either. The precious metal’s price was little changed during the month.

This stark breakdown in historical correlations between what traditionally have been deemed to be risky assets and those seen as mitigating risks is not a first. Indeed, investors have benefited quite a bit recently from periods in which the prices of both stocks and bonds have gone up at the same time. It is just a lot more noticeable when both are falling at the same time. And it’s a reminder that it’s not only a one-way bet when it comes to markets that are heavily distorted by central bank intervention.

October saw a number of developments that blunted what has been a persistently strong ability of ample and predictable liquidity injections – together with the bullish investor behavior it has encouraged, especially as it relates to stocks – to compensate for all sorts of uncertainties. While the breakdown in this formula may be partly attributable to election-related issues, the real culprits are the global economy’s loss of momentum and political parties’ persistent failure to agree on a new fiscal relief package. November is likely to see further challenges to both.

Saturday’s announcement of a one-month lockdown in England is yet another indication of the difficulties most of Europe faces in balancing public health, economic and social needs — not to mention personal freedom — during a pandemic. On the other side of the Atlantic, the U.S. is experiencing its own surge in Covid-19 infections. Judging from the course the outbreaks are taking in Europe, which is regarded by many medical experts as a leading indicator for the U.S., it is just a matter of weeks until the rise in U.S. cases is also reflected in higher hospitalizations and deaths.

Several U.S. states will be less willing than European governments to impose lockdowns, but we should still expect a notable slowing in private-sector activity as households and businesses take more precautionary steps on their own. There is only a limited prospect that a fiscal package will come together in the next couple of months to compensate for the resulting income losses.

This week’s meeting of the Federal Reserve will show whether, similar to the European Central Bank, the world’s most powerful central bank is willing to “recalibrate” its policy stance to counter the more difficult economic and market outlook. Investors are hoping that, once again, U.S. central bankers will reaffirm that the “Fed put” is robust and reliable. Yet a growing number of economists wonder whether another loosening of monetary policy will have any impact other than to widen the already-large disconnect between a profitable Wall Street and a struggling Main Street, and the worsening in the inequality trifecta (income, wealth and opportunity) that comes with that. Some of us go one step further in worrying about the longer-term damage to the central bank’s credibility, its effectiveness, and the functioning of markets more generally.

So, what does all this mean for investors? Most importantly, it highlights the importance of recognizing that we are operating in highly distorted markets whose upward trajectory depends ever more on the persistence of investors’ collective faith in the power of an already-stretched monetary policy stance to compensate for a growing number of headwinds. These include risks to economic, social and corporate wellbeing, as well as to the structural integrity of markets. It is a reality that has eroded the effectiveness of conventional portfolio diversification - what many refer to as the 60/40 investment mix of stocks and bonds. As for mitigating risks, absent a willingness of the Fed to cross the Rubicon in opting for explicit yield targeting, investors are left with few choices other than outright cash holdings, very short maturity bonds and, for more sophisticated investors, various derivative-based hedging exposures.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include "The Only Game in Town" and "When Markets Collide."

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