Why New Year’s chaos may signal a more balanced — but volatile — stock market in 2022 as investors grapple with a hawkish Fed

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After Santa Claus barely hung up his shoes after delivering his famous rally to nice little stock-market investors, then everything fell apart.

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The past week saw major market volatility as investors turned to the first week of trading in 2022, and market watchers pointed to the potential for more volatility as they fight inflation without plunging the economy into recession. of the Federal Reserve’s ability.

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“I think the markets are trying to figure out how aggressive the Fed will be in removing and tightening housing and if it will likely make a policy mistake,” Ed Keon, QMA’s chief investment strategist, said in a phone interview.

The release of minutes of the Federal Reserve’s December 14-15 policy meeting on Wednesday added to the uncertainty. He disclosed that policymakers had discussed being more aggressive in raising rates than previously expected and talked about the possibility of sharply reducing the size of the Fed’s balance sheet when it announced the first round of quantitative easing. was terminated. Financial Crisis.

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This added fuel to the bond-market selloff, which saw a return on the 10-year Treasury note TMUBMUSD10Y,
1.767%
A jump of 27 basis points, or over 0.27 per cent, in the past week, the biggest such increase since September 2019. At 1.769%, this rate is the highest since January 17, 2020.

Before the minutes, the Dow Jones Industrial Average (DJIA),
-0.01%
And there was an increase of 2.4% in the last five trading days of 2021 and the first two days of 2022 – the stretch that defines the so-called Santa Claus rally. For the Dow, it was the strongest run for a seasonal event since 2008-09, when it rose more than 6%. s&p 500 spx,
-0.41%
Courtesy of St Nick’s got 1.4%, the strongest such run since 2012-13.

But the jump in yields didn’t help tech and other rate-sensitive growth stocks, which started taking losses just last month. Tech-Heavy Nasdaq Composite Comp,
-0.96%
Santa had completely missed the rally, down 0.2%. On Wednesday, it posted a fall of more than 3% for its worst one-day performance since February.

Valuations for growth companies are based on expected cash flows in the future. Higher interest rates mean that cash is not as valuable as it was when rates were lower.

The Dow and S&P 500 also suffered losses, and all three major indices ended the week with losses, although the Dow and S&P 500 ended only 1.5% and 2.5% off record levels on Jan. 4 and Jan. 3, respectively. With Bitcoin BTCUSD, crypto traders also appeared upset by the minute,
+0.02%
Slipping to a three-month low, that left the world’s largest digital asset with its worst start to a calendar year since 2014.

Value stocks beat their growth counterparts in the first week of 2022, adding to the outperformance seen in December. Russell 1000 Value Index RLV,
+0.23%
rose 0.8% over the past week, while the Russell 1000 Growth Index RLG,
-1.09%
It fell 4.8%, according to data from FactSet. In December, the Russell 1000 Value Index climbed 6.1%, to surpass Russell 1000 Growth’s advance of 2.1%, for its biggest monthly gain since November 2020.

Value stocks have pulled ahead of growth in recent weeks. Is this head-fake?

At the sector level, tech fell 4.7% over the past week, while deeper value cyclical sectors surged, noted Brian Levitt, global market strategist at Invesco. The financial sector grew by 5.6 percent, while energy grew by more than 10 percent. And the defensive consumer-staples sector managed growth of about 0.4%.

This does not mean that investors should rush to pursue rotation, he said in a note.

“Basically, we see the Fed harnessing the brakes by guiding higher interest rates and flattening the yield curve to warm the US economy. In that context, we think it’s too soon to deep- Prices have to move around in a cyclical, which will likely require a yield curve and economic re-acceleration,” Levitt said.

In the absence of an economic downturn, the timing is also wrong for investors to load up on defensive stock areas, he said, as they are unlikely to outperform meaningfully until the end of the current market cycle.

Keon of the QMA doesn’t expect the Fed to overdo it, but cautions that it is a non-negligible risk as policymakers follow the inflation of a $5 trillion fiscal stimulus and the central bank’s own decisions on the monetary-policy front. deal with aggressive actions.

He noted that a shift from an environment of free-flowing liquidity to one in which policymakers are closing spigots and liquidating liquidity does not provide positive returns for equities and other riskier assets, but one in which to expect. No need to be bold. More suppressed gains after the S&P 500’s annual price rose 28.9% in 2019, 16.3% in 2020, and 26.9% in 2021.

For his part, Keon expects inflation to ease as supply-chain bottlenecks ease. The Omicron version may cause economic growth to hiccups in the first quarter, improving in the second quarter as investors wait for the end of 2022-2023 to be sustainable.

Rising yields aren’t necessarily negative for stocks — after all, a stronger economy should lead to higher rates — but they are a huge relative headwind for growth stocks. Keon said he doesn’t expect price increases to “crush” in the coming year, but the stage could be set for a more “balanced” market rather than one marked by narrow leadership.

Much weaker-than-expected growth in December’s non-farm payrolls on Friday did nothing to ease upward pressure on yields, with investors focusing instead on the unemployment rate, which unexpectedly dropped from 4.2% to 3.9%. while average hourly earnings showed a strong increase.

“An increase of 4.7% in annual hourly earnings, coupled with a fresh pandemic spike of 3.9% in the unemployment rate, is a clear sign of a tight labor market if ever there was one, and will likely beat the Fed in a light to monetary tightening. ,” said Seema Shah, chief strategist at Principal Global Investors, in emailed comments.

Traders, unaffected by December’s shoddy job gains, continue price tightening by Federal Reserve ‘quickly and sharply’

The “December Jobs Report” is not going to pick up steam from bond yields, nor are headline payroll numbers enough to reassure markets of a very strong economy, Shah wrote. “Equity markets are on the line for a volatile month.”

The coming week, meanwhile, should provide fodder for volatility, with the economic calendar featuring the December Consumer Price Index reading on Wednesday, the December Producer Price Index on Thursday, and the latest reading from the December Retail Sales and Consumer Sentiment Survey of the University of Michigan. Is. on Friday.

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