Written by Jon Gumpel, Investment Manager of the SVS Aubrey Citadel Fund
The view that is determining the positioning of the Citadel Fund, is that a slowdown is looming and not fully priced by markets.
The last month saw a spike in US and UK interest rates. Inflation looks sticky and the lagged effects of rate rises to date have not quite borne fruit. In my view, the supports for growth and, to a lesser extent, inflation are dropping away quite quickly. Bonds and bank shares are typically good indicators of this, and both bond volatility (MOVE) and regional bank share (KRE) volatility have increased sharply, indicating at the very least uncertainty going forwards.
Equity volatility (VIX) remains decidedly complacent. The gap between VIX and Rates is almost the highest since 2000 and between VIX and Banks is almost the highest since 2008. It would seem the S&P500 is ignoring both rate risk and bank risk to an unprecedented degree. Given these two are both indicators of recession, it is sensible to consider the historical impact of recessions on S&P drawdowns. Some people are suggesting that, given the falls last year, it could be that the equity correction happened in advance of the recession.
So, in order to determine whether this is magical thinking or soundly based, we have to consider the history of recessions and their effect on equity markets. The chart below shows that the greater part of the max drawdowns take place during the actual recession, and not the 12m prior.