For those investors who thought we may ease into the new year – markets had a different plan. After a storied 2021 with exceptional market gains and mild pullbacks, 2022 has started off with turbulence. The S&P 500 saw an intra-month decline just shy of 10% (based on closing prices) before rebounding smartly to cut its losses by nearly half by month end. Growth and more speculative areas of the markets, including the famed meme and story stocks, were among the areas hardest hit. These market segments benefitted the most from the abundance of liquidity early in the recovery and are among the most vulnerable as policy support lessens.
Still, the weight of the evidence suggests what we saw in January was a correction within an ongoing bull market. Market pullbacks are never comfortable but are the admission price to the market. Since the 2009 market low, the S&P 500 has risen about 570%, despite 25 corrections of at least 5% by our count. Moreover, historically following shallow pullback years, such as 2021, the S&P 500 has tended to see an average pullback of 13% the next year.
Notably, we can trace the start of the market’s recent setback to the January 5th release of the Federal Reserve’s (Fed) meeting minutes, which further set the stage for this year’s expected transition in monetary policy. Consequently, the 10-year U.S. Treasury yield spiked back to pre-pandemic levels. This sharp move led to a recalibration within the market and caught some participants offside.
We are no longer in crisis mode – therefore, monetary policy should reflect that. Indeed, the job market and economic output have snapped back faster than almost anyone anticipated, and taming elevated inflation is now the top focus of the Fed. In our view, the larger surprise is that rates hadn’t moved up earlier as our team thought rates were too low relative to the still-strong economic and inflation environment.
The primary market trend appears higher aided by an economy on solid footing and resilient earnings. And, we are also encouraged that the market is already pricing in a great deal of rate hikes, that investor sentiment has reset sharply, and that valuations have pulled back. Indeed, bearish sentiment has risen to its highest levels since the pandemic started, and valuations just saw one of the sharpest contractions witnessed over the past 10 years – both of which have tended to be followed by positive market returns on an intermediate basis.
That said, after the fierce snapback seen into early February, we expect markets to remain choppy near term. Moreover, as the cycle matures and the market’s risk/reward becomes somewhat less favorable relative to early in the cycle, it makes sense to remain positive yet realistic.
Within equities, we maintain a U.S. bias. International markets have outperformed early into the new year, but as pointed out in our outlook, these markets entered the year very oversold and were due for a reprieve. We are waiting to see better relative earnings trends before shifting our position but are seeing some incremental improvement. Within fixed income, our theme of higher rates and higher volatility is playing out. We remain underweight bonds, though the rise in yields has incrementally improved the outlook. We maintain an overall credit bias within fixed income given our positive economic view and also see relative value in leveraged loans.
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