Equity pain may be yet to come, Cerulli reports

After surveying the unprecedented chaos swirling through financial markets in the first half of this year, Cerulli Associates analysts believe the storm is just getting started.

A key factor is the behavior of investors who are not able to react as they usually would amid market turmoil, according to Cerulli’s monthly trends report.

“From supply chain issues to pent-up demand and inflationary pressures, what is happening today is driving confidence levels to historic lows,” according to the report. “Yet investors seem to not yet be reacting as expected, particularly regarding equity flows.”

Analysts acknowledged that seasoned investors warn against the phrase “this time is different,” but they begrudgingly admitted that this time is indeed different with the many unusual factors including the global energy price shock, supply chain issues, inflation and the invasion of Ukraine, among others. The equities market is in its first bear phase since the 2008 crash, except for the rapid plunge and recovery of March 2020.

“...Investors seem to not yet be reacting as expected, particularly regarding equity flows.”
— Cerulli Associates

Funds across the board are losing money, including bond funds. Mutual funds had a tough April, losing 7.2% before the modest loss of 0.5% in May. ETFs also lost significantly, starting the year with $7.2 trillion and dropping to $6.6 trillion, despite gaining $250 billion in net flows. The only winners were municipal bond and commodities asset classes.

Analysts said the dynamics between bond and equity funds indicate a deeper dive is coming.

“If the bond markets are a leading indicator, it may be that the pain has not yet hit equity funds, and elevated levels of selling are just around the corner,” according to the report, adding a glint of rebound hope. “Conversely, the significant levels of cash on the sidelines may be deployed in the market as price declines occur and investors seek to ‘buy the dip.’”

Big losses at the big players

Execs at the world’s largest asset holder, BlackRock, sounded a similar tone during the company’s second-quarter earnings call on Friday.

BlackRock lost $1.7 trillion in AUM since the beginning of the year due as investors reacted to rising recession fears, surging inflation, interest rate hikes and geopolitical tensions, said CFO Gary Shedlin. The company still managed an industry-leading $175 billion of net inflows in the first half.

CEO Larry Fink said they are seeing historic movement in markets because of these unusual times.

“2022 ranks as a worst start in 50 years for both stocks and bonds,” Fink said, “with global equity markets down 20% and the aggregate bond index down about 10%.”

The company plans to postpone hiring along with other measures, but still expects to finish the year with 15% growth and $10 trillion under management.

Goldman Sachs also expects to slow hiring, execs said during the company’s quarterly earnings call today.

Inflation is deeply embedded in the economy, adding to an uncertain environment that will lead the company to be cautious for the rest of the year, including on stock buybacks, said CEO David Solomon.

“I expect there’s going to be more volatility and there’s going to be more uncertainty and in light of the current environment we will manage all our resources cautiously,” Solomon said.

Although Goldman lost 48% in profit in the second quarter, the loss was less than expected because of strong sales work in the consumer and wealth management segment, which saw a 24%, or $2.18 billion, increase in

Money market refuge?

The usual refuge in equities tumult is the money market, but that is a no-go because of inflation, said the Cerulli analysts. Usually money would be pouring into money market funds in a downturn. For example, during the brief bear market of 2020, $686 billion flooded into money market funds in March alone. This year, those funds lost $200 billion between January and May.

The report noted that more than 80% of financial advisors use money market funds for downside risk protection, which is difficult now with inflation.

The analysts said advisors could prepare money market strategies if rate hikes do cool down inflation. Advisors could position funds in anticipation of that demand while preparing marketing content and strategies to send out timely information in reaction to market shifts, according to the report.