Markets Stumble to Start the Year | January 25, 2022

Three weeks into the year it is difficult to point the finger at any one cause for the market’s precipitous decline and rather than fall victim to an overconfidence bias, here are three keys themes that in aggregate, are contributing to discontent. At the forefront of volatility is the changing outlook for interest rates. Leading this shift is the world’s most influential central bank, the United States Federal Reserve. The bank’s policy setting committee, the Federal Open Market Committee (FOMC), is set to meet this week and at its conclusion Wednesday, Chairman Powell will provide investors with an update on the Fed’s monetary policy position. Investors will be eagerly listening to Powell’s announcement, parsing every word for details on when the first fed funds rate hike will occur and the anticipated monthly pace of balance sheet reductions(1). While stock markets can influence Fed policy decisions, most recently in December 2018, forward guidance and recent economic data suggest that inflation is likely to remain the key topic of discussion, despite the decline in equities to start the year. As such, investors have responded by quickly adjusting their expectations for where rates are headed. In fact, according to the CME’s FedWatch Tool as of this past Monday(2),there is roughly an 88% probability of three or more rate hikes before the end of the year. This shifting view has driven bond yields higher across the majority of the term spectrum(3), impacting discount rates, real yields, and mortgage rates, all to the detriment of stock prices.

 

In addition to rising rate expectations, two substantive geopolitical risks are on the rise with few clear solutions to combat them. In Europe, Russia continues to amass troops along Ukraine’s border, threatening action should NATO’s future membership not explicitly exclude former Soviet bloc nations. While economic and financial sanctions have been threatened, few have been imposed, and while the US stands ready to reposition troops into nearby NATO countries, the support of European member nations remains clouded by the region’s dependency on Russian natural gas supplies. Complicating a global response to Russia’s aggressiveness, China continues to expand its nuclear facilities and suggest that Taiwan should be reunited with the homeland. Should Russia invade Ukraine and China invade Taiwan thereafter, the United States’ and NATO’s response would be complicated.

 

Beyond monetary policy and geopolitical risks, investors are also keenly aware of the recent mixed economic data. China, the world’s second largest economy, recently reported 2021 GDP growth of 8.1%, up 5.9% year-over-year, but noted that economic activity had slowed sequentially the last two quarters of the year, falling to an annualized pace of 4.9% and 4.0%(4). Recognizing the slowdown in economic activity, the People’s Bank of China subsequently cut its one-year loan prime rate 10 bps to 3.7% shortly thereafter(5), affirming the anticipated divergence in monetary policy positioning between emerging and developed countries. Domestically, factory activity reported from the New York Fed(6) for the same region recently surprised to the downside, only to be offset by an upward surprise to factory activity in the mid-Atlantic region(7). Additionally, a recent measure of home builder sentiment fell as supply shortages, building material price increases, and rising mortgages rates weighed on the near-term outlook, despite home starts ending 2021 at the highest level since 2006 and building permits rising 17.2% last year, suggesting that 2022 could have a very strong start(8).

 

With this as a backdrop, developed equity markets have traded lower with growth stocks particularly impacted. Leading declines for the week ending January 21^st(9), the NASDAQ index gave back 7.6% while the Russell 1000 Growth index fell 7.0%; both indices are now trading in correction territory(10), down 14.2% and 13.4%, respectively.  The S&P 500 index fell 5.6% for the week and is down 8.3% from its recent high. While not unscathed, the value biased DJIA and Russell 1000 Value indexes have lost less with both indexes giving back 4.6% for the week, and -5.6% and -3.6% for the year.

 

International equities delivered mixed results, with the MSCI EAFE index declining 2.1% for the week and down 2.2% for the year. Bucking the trend all together, in part because of China’s influence, the MSCI Emerging Markets Index lost 1.0% on the week but remains up 1.0% for the year.

 

The broad measure of US credit markets, the Bloomberg US Aggregate Bond index, rose for the week as yields declined, gaining 0.1%, but for the year the index is down 1.8%. The US 10-year Treasury Note fell 0.12% for the week to 1.75% but remains up 0.12% for the year. The short-term 1-year Treasury bill yield was unchanged, ending at 0.58%, but has risen 0.18% to start the year.

 

For more information, please contact any of the professionals at Cedar Cove Wealth Partners.

 

Footnotes

1. Details of the January FOMC announcement can be found online at, https://www.federalreserve.gov/monetarypolicy.htm
2. CME’s FedWatch Tool as of 1/24/2022, https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html
3. gov Daily Treasury Rates, https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield
4. National Bureau of Statistics of China, http://www.stats.gov.cn/
5. People’s Bank of China, http://www.pbc.gov.cn/
6. Federal Reserve Bank of New York, https://www.newyorkfed.org/survey/empire/empiresurvey_overview
7. Federal Reserve Bank of Philadelphia, https://www.philadelphiafed.org/surveys-and-data/regional-economic-analysis/mbos-2022-01
8. Wells Fargo, Weekly Economic & Financial Commentary, January 21, 2022, https://wellsfargo.bluematrix.com/links2/html/10af1965-fc62-4c5b-8732-b6fbf0271f18
9. All referenced return data is through January 21, 2022. Domestic returns reference the total return index, international indexes reference net returns.  Year-to-data refers to the period of January 3 – January 21, 2022.  Correction references are from the most recent high, which varies by index, through January 21, 2022.
10. A correction is commonly defined as a 10% decline from the most recent high.

 

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