We are just a few weeks into the new year, and the market environment is already continuing to challenge the high-flying stocks of the last five years. Not only are investors realising that monetary policy tightening is inevitable in 2022, but it has now also become clear that the Federal Reserve (Fed) is willing to raise interest rates earlier, faster and, importantly, concurrently with a large balance-sheet reduction.
This has led to heightened stock-market volatility, underpinning one of the biggest market rotations in years away from rate-sensitive, long-duration growth-style stocks toward value.
U.S. stocks have been falling since the start of the year, with the Dow Jones Industrial Average and the S&P 500 index all down sharply in the month to date, as Treasury yields rise in anticipation of the Fed tightening monetary policy this year. The rate-setting Federal Open Market Committee next meets on 25-26 January and is likely to set the stage for a series of rate increases expected to start in March and will also start to reduce its balance sheet (debt) as it combats inflation. Rising yields are weighing on yield-sensitive tech stocks and growth-themed areas of the market as a rapid rise in interest rates makes their future cash flows less valuable, and in turn makes the popular stocks appear overvalued, and that is causing a broad recalibration of the tech and tech-related shares that populate the Nasdaq. The US technology heavy Nasdaq Composite Index fell below its 200-day moving average for the first time in well over a year, ending its 3rd-longest streak above that long-term average. It also fell into correction territory, down more than 10% from its peak, for the first time in over 200 trading sessions.
There are several different arguments to focus on as to whether this pressure on growth stocks will continue, or whether it will recede quickly as it did in the summer of 2021. Inflation may well be reaching a peak as supply-chain disruptions ease and the Omicron wave of the pandemic subsides, potentially easing upward pressure on longer-term interest rates. There have been signs that inflation is peaking. Inflation expectations have been stable recently, the pace of U.S. factory activity expansion has slowed, and China’s factory prices have increased at a lower-than-expected rate.
All these factors complicate portfolio construction. As investors face reduced market liquidity, expensive mega-cap tech stocks are still vulnerable to another pullback. The rotation toward cyclicals and value, while likely sustainable, could become challenging if policy tightening coincides with organically slowing growth and inflation.
Away from the markets we have welcome news of the removal of Plan B COVID measures and a full return to office working. It will be interesting to follow the continued developments with regards to the need to regularly test and isolate as it appears the Government is working towards a significant change in policy by the Spring. Do have a good weekend, as always, should you have any questions, please do not hesitate to be in touch.