- The 5.4% pullback for the S&P 500 from the early January peak is now deeper than the sharpest correction of 5.2% seen in all of 2021, with other areas of the market, such as growth stocks, down much more.
- The main investor concerns appear to be uncertainty around the timing and pace of monetary policy tightening, the persistence of inflation, and potential profit margin pressure.
- We have been expecting more normal pullbacks this year. Still, given that markets are driven by how data comes in compared to expectations, we are encouraged that the market is already pricing in a great deal of policy tightening, that investor sentiment has reset sharply, and valuations have pulled in.
While the timing to start the year is challenging, deeper and more frequent pullbacks should be expected this year. This is consistent with our work showing shallow pullback years tend to be followed by deeper pullbacks the next year, and our expectation that shifts in Federal Reserve (Fed) policy would inject volatility into the markets. For perspective, this setback is coming after 25%-plus gains for the S&P 500 in 2021 and the fastest start to a bull market in history.
The main investor concerns appear to be about the pace of tightening in Fed policy, the persistence of inflation, and potential profit margin pressure. A silver lining to this nervousness is investment sentiment has sharply reset over recent weeks. This is important. Markets are driven by how data comes in relative to expectations. The bar for positive surprises has been reset lower.
Part of the recent market disruption is related to the sharp movement in interest rates. The 10-year U.S. Treasury yield has risen about 50 basis points since late December. While the absolute level of rates, which is simply returning to pre-pandemic levels, is consistent with our outlook, the speed of the move has been sharp and likely caught some market participants off-guard. In our view, the larger surprise is rates hadn’t moved up sooner as our team thought rates were too low relative to the still-strong economic and inflation environment.
Going back to expectations, at the end of September, markets were pricing in one Fed rate hike for 2022. Since then, this has shifted to four. The good news is that if the Fed does proceed with four hikes, it wouldn’t be a surprise. Accordingly, it should be less disruptive to markets if we see four or less rate hikes, which is consistent with our team’s overall view this year.
To read the publication in its entirety, please click the button below "Download PDF".
Request Accessible PDF
An accessible PDF allows users of adaptive technology to navigate and access PDF content. All fields are required unless otherwise noted.