Marko Kolanovic and John Stoltzfus, two of the loudest stock bulls on all of Wall Street, were convinced of one thing at the outset of 2022: The Federal Reserve would go slow, very slow, with its plan to lift interest rates.
Nevermind that inflation had already soared to its highest level in four decades. The rate increases, they said, would come in increments so small that financial markets would barely feel them.
And so Kolanovic, JPMorgan Chase's co-head of global research, predicted a broad rally. He and his team pinned the S&P 500 Index at 5,050 by the end of 2022. Stoltzfus, the chief investment strategist at Oppenheimer, was even bolder: 5,330.
They were off by more than 1,000 points.
The two men — high-profile personas at big-name firms — are the public faces of what can only be described as the blindsiding of Wall Street. With few exceptions, the best and brightest in stock and bond markets failed to appreciate how the inflation outbreak would upend the investing world in 2022.
They failed to anticipate how the Fed would react — the rate increases came at a torrid, not measured, pace — and failed to foresee how that, in turn, would trigger the worst simultaneous rout in stocks and bonds since at least the 1970s.
There are 865 actively managed stock mutual funds domiciled in the U.S. with at least $1 billion in assets. On average, they lost 19% in 2022. Equity-loving hedge funds got hammered, too. On the bond side — a universe of 200 funds of a similar size — the average decline was 12%.
A majority of them fared worse than the indexes they use as benchmarks to gauge their performance. Prominent among those was Western Asset Management's biggest mutual fund — the Core Plus Bond Fund.
Ken Leech, the company's chief investment officer, was, just like Kolanovic and Stoltzfus, convinced the Fed was in no hurry. In late 2021, he predicted there might not even be any rate hikes at all in 2022. The fund, a $27 billion powerhouse, lost 18%. It underperformed 99% of comparable funds.
"A 40-year bull market," says William Eigen, a bond investor at JPMorgan Asset Management and one of those rare exceptions who had positioned his fund to avert the pain to come, "does funny things to you."
It sears core beliefs into the brain that are hard to erase. Ever since the late 1980s, thousands of traders, investors and analysts were schooled in the ways of the Fed put, a belief that policy makers were always there to prop up markets in moments of turbulence — by scaling back plans to raise rates or outright cutting them — and, therefore, you should always buy the dip.
A trader on the floor of the New York Stock Exchange. (Photo: Bloomberg)
'Like a Mugging'
The magnitude of the rout this year, to be fair, was hard to foresee. Both Leech and Stoltzfus, when contacted for comment, cited the unexpected shocks to the global economy that reverberated across markets.
There was, for instance, China's insistence on sticking to its Covid Zero policy for most of the year and Russia's invasion of Ukraine. "This was really like a mugging the way it happened," Stoltzfus said in an interview. "You had China, you had Russia, and then you had the process of the Fed doing what it finally had to do."
Leech called the year "particularly challenging," but noted that the fund's performance has started to improve. It's gained 3.6% this quarter. "Recognizing changes in the macro environment, we have made adjustments to our broad market portfolios and believe the fund is well positioned to benefit from a global recovery," Leech said in a statement.
Kolanovic pointed to the performance of a broader cross-markets model portfolio he oversees. It posted a positive return this year, he said in a statement, as winning bets on commodities and bonds offset the wrong-way wagers on stocks.
A year ago, he and the JPMorgan team had predicted some of the surge in yields in 2022, saying those on benchmark 10-year Treasuries would climb to 2.25%. They hovered at 3.88% late Wednesday.
The Fed Put
It was in the aftermath of the last big inflation outbreak in the U.S. that the Fed put axiom was born. With consumer prices stable once again by the mid-1980s, central bankers were free to focus primarily on supporting economic growth, jobs and, in the process, buoy stocks and bonds.
That the put is dead, for now, at least, in this new era of high inflation, hasn't quite sunk in on many trading floors. Eigen sees this in the way traders clamor again and again for a "Fed pivot."
By pivot, they mean a move away from sharp rate hikes and toward cuts meant to stave off a recession. This has led them to repeatedly bid up prices of bonds and stocks in fleeting relief rallies that sputter and crash when Fed Chair Jerome Powell forcefully reiterates that he and the board are forging ahead with rate increases until inflation is back under control.
