There’s been a lot of volatility and fear in the markets recently that’s causing a sell off. I thought I’d quickly share a few points to put thing in perspective.
The start of 2022 hasn’t been kind to equity investors, U.S. in particular. As of Friday, the Dow Jones Industrial Average, S&P 500, and NASDAQ Composite price indices were down approximately 5%, 7%, and 11%, respectively since the beginning of the year. The NASDAQ has also fallen into correction territory, as it is down more than 10%.
The change in market sentiment in the short term can be tied to the uncertainty around the path of the U.S. Federal Reserve’s rate hikes. The consensus now believes that the Fed will increase rates four times instead of two to fight against elevated levels of inflation. That has resulted in a 32-basis point jump in the U.S. 10-year Treasury yield.
While the Fed has communicated that it’s likely to begin raising interest rates sooner than originally expected, many economist and portfolio managers I’m talking with don’t believe this is a cause for concern. The view is, despite the short-term volatility that a pivot in monetary policy will create, it’s a positive development. This is because the Fed is signaling that they no longer feel the economy needs the ultra-accommodative monetary policy implemented during the peak of the crisis in early 2020. They’re simply reducing the additional support. The Fed isn’t raising rates from a neutral posture but rather starting to move away from the zero bound. In the short term, markets tend to react negatively even to the idea of the Fed taking away aids despite where we actually are in the economy.
Higher growth companies that have benefited from low interest rates to support their longer duration revenue streams are bearing the brunt of this shift in yields. The recent sell off is broad based with good quality businesses getting caught up in the downturn. This can be explained in part to the increased adoption of passive investment vehicles, aka indexes and ETFs.
We’re also in the early stages of Q4 earnings season, and the market seems to be rewarding or punishing individual companies based on their announcements. It’s not just about Q4 results but also their forward guidance. Supply chain issues and elevated input costs are creating uncertainty for some companies over the next few quarters, and this is adding to some of the price pressure.
Geopolitical risk is also factoring into the market unrest, as renewed tensions between Russia and Ukraine, among others, top headlines. Geopolitics are always in the background, but when there are flare-ups, we often see short-term market reaction. However, recent history shows that these are usually disruptive rather than destructive to the markets.
For the long-term investor, it’s important to remain focused on the fundamentals. Nothing has changed for a positive 2022 outlook, however, we need to expect some volatility along the way.
Please let me know if you have any questions.