Risk Assets Swept Up in Rout as 'Fear Gauge' Soars

"This is a more draconian outcome than corporate profits falling," he noted, "because it will encourage the Fed to tighten even further."

Flocking to Cash

Investors are flocking to cash and shunning almost every other asset class as they turn the most pessimistic since the global financial crisis, according to Bank of America Corp. Investor sentiment is "unquestionably" the worst it's been since the crisis of 2008, with losses in government bonds being the highest since 1920, strategists led by Michael Hartnett wrote in a note.

"It's a realization that interest rates are going to continue to rise here and that that's going to put pressure on earnings," said Chris Gaffney, president of world markets at TIAA Bank. "Valuations are still a little high even though they've come down, interest rates still have a lot further to go up and what impact that will have on the global economy — are we headed for a sharper recession than the recession everybody expected? I think it's a combination of all of that, it's not good news."

Extreme Pessimism

Stocks are indeed still far from being obvious bargains. At the low in June, the S&P 500 was trading at 18 times earnings, a multiple that surpassed trough valuations seen in all previous 11 bear cycles, data compiled by Bloomberg show. In other words, should equities recover from here, this bear-market bottom will have been the most expensive since the 1950s.

Bleak sentiment is often considered a contrarian indicator for the US stock market, under the belief that extreme pessimism may signal brighter times ahead. But history suggests that equity losses may accelerate even further from here before the current bear market ends, according to Ned Davis Research.

The firm's Crowd Sentiment Poll has been in an extreme pessimism zone since April 11, or 112 consecutive trading days that mark the third-longest streak of gloom since the data began in 1995.

Over the subsequent few months following those periods of extreme pessimistic sentiment, equity gains were fleeting, with negative median returns three and six months after the 100-day mark.

In another threat to stocks, different iterations of the so-called Fed model, which compares bond yields to stock earnings' yields, show equities are least appealing relative to corporate bonds and Treasuries since 2009 and early 2010, respectively. This signal is getting attention among investors, who can now know look to other markets for similar or better returns.

"The next question is when and how far do earnings estimates decline for 2023," said Ellen Hazen, chief market strategist and portfolio manager at F.L. Putnam Investment Management. "Earnings estimates for next year are too high, they really have not come down, and as that happens you're going to have further equity pain because in addition to the multiple coming down via the yield mechanism, the earnings you're applying that multiple to are going to come down as well."

As slower growth and tighter financial conditions start catching up to companies, a wave of downgrades will come for the US investment-grade corporate bond market.

That's according to strategists at Barclays Plc, who say companies are facing margin pressure thanks to high inventories, supply chain issues, and a strong dollar.

The firm expects the average monthly volume of downgrades to increase to $180 billion of bonds over the next half year. The current monthly average is closer to $40 billion.

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