January was a bruising month for global stocks, particularly U.S. stocks. But on the bright side, the S&P 500 ended the month with its best two-day rally since April 2020.
Nine of the eleven economic sectors in the S&P 500 ended the month down. Energy stocks appreciated an astounding 19% as oil prices moved higher on geopolitical tensions in eastern Europe and on recovering demand.
International bourses, comprising of fewer technology companies and trading at lower valuations, outperformed U.S. stocks.
At one point, the S&P 500 was down 10% from its highs, an unnerving experience given the steady gains investors have grown accustomed to recently. But corrections of this magnitude are more common than one might think.
Historical return data for U.S. large-cap stocks shows that one should expect at least one 10% correction in stocks every year. In years of double-digit intra-year dips, three out of every five years have ended in positive territory. There is no set schedule, but it is important to remember that enduring bouts of short-term pain are part of the long-term investment process. These corrections can, and often do, present opportunities.
At the Federal Open Market Committee (FOMC) meeting this month, Jerome Powell reiterated the Fed’s intent to hike short-term rates, likely in March, conclude asset purchases, and reduce its balance sheet.
Yet, precisely how aggressive the Fed will be is open to speculation. At the moment, the market is anticipating four to five rate hikes in 2022. Some economists are forecasting an even faster pace. The Fed is walking a tight rope of controlling inflation while keeping the economy growing at a healthy rate.
Frothier pockets of the U.S. market such as tech companies and retail crowd favorites repriced significantly around the Feds comments. These companies are more vulnerable to the uncertainty around monetary policy since the majority of their value is derived based on future growth expectations. One might even say a repricing has been in order given the irrational exuberance priced into these certain high-flying growth stocks.
While the market’s estimation of long-term inflation has held steady, real yields have risen quickly to start the year. The Bloomberg U.S. Aggregate bond index fell -2.2% in January, one of the worst months on record for the broad bond index.
The omnipresent coronavirus and its seemingly endless march of variants still hang over the markets. It continues to circulate and cause persistent supply chain issues, slowing economic growth. But the recent Omicron wave appears to be receding in certain parts of the world, and a return to economic normalization seems closer.
Stocks and Rising Interest Rates
With the Fed ready to raise short-term interest rates to combat inflation, investors are worried that higher interest rates will hurt stock returns.
In theory, higher interest rates should lead to lower stock prices. As interest rates rise, the future value of a company’s earnings, dividends, or cash flows are less valuable, all else equal. However, rising interest rates are often accompanied by strong economic and earnings growth.
In general, stocks have performed well in times of higher interest rates. Since the 1970s, the average return for the S&P 500 in periods of increasing interest rates is about 14%.
S&P 500 returns were in positive territory for the most of these cycles. The lone exception is the early 1970s which consisted of the 1973 oil embargo that plunged the U.S. economy into a stagflation recession.
What It All Means
Investors have grown accustomed to steady, consistent gains over the past couple of years. So, it only seems natural that the recent market volatility feels more pronounced and unnerving. But, while volatility is expected, it never feels comfortable when it is here.
Trying to trade and profit from the volatility can be an elusive endeavor that could further exacerbate losses. In times like these, it is important to stay grounded in a long-term investment strategy. Again, remembering that volatility is part of a healthy financial market is important.
As always, if you have had a change in circumstances or would like to discuss your investment portfolio, please do not hesitate to reach out.
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