Investor sentiment felt quite bullish going into 2022. All the major US stock indices were trading at, or close to, their all-time highs. To be sure, inflation was picking up and it was looking increasingly likely that most developed-world central banks would have to take action to do something about rising prices. But rates of unemployment were low, particularly in the US and UK, and approaching pre-pandemic levels. And don’t forget that those pre-pandemic levels were multi-decade lows themselves, to such a degree that the Federal Reserve felt that the US could be operating at a level of maximum employment. The trouble was that the pick-up in inflation following its post-pandemic plunge proved to be anything but transitory. Central bankers got it wrong again. The big question, now they’ve woken up to this fact, is whether their current response in the form of aggressive rate hikes prove to be the correct medicine or not?
Rate hike worries
Financial markets suggest a certain lack of faith in the Federal Reserve. Or perhaps it would be more accurate to say that investors fear that the Fed has every intention of following through with its newfound hawkishness. The trouble is that tightening monetary policy aggressively in a belated attempt to push the inflation genie back in its lamp is not the right move given where we are in the economic cycle. Western economies have already had their post-pandemic surge (when a reduction in monetary stimulus would have been timely) but now growth is slowing. On top of that, there are still supply disruptions which must be worked through while energy prices remain stubbornly high as the Russian invasion of Ukraine continues.
The sell-off which greeted the global lockdown in response to the coronavirus pandemic was brutal. The S&P 500 fell 35% in the space of a month. But the stock market recovery was equally fierce. It took the S&P just five months to recover to a fresh record high. That was quite remarkable when you consider all the negative sentiment at that time. Then the index added an additional 42% with only the briefest and shallowest of pullbacks along the way. The March 2020 low to the January 2022 high was the perfect example of a stock market bull run. But now many are saying that the party is well and truly over. Rather than buying the dips, investors are selling the rips as all the major indices are flailing about at lower levels. In fact, the S&P is back below 4,000 or 17% off its record high, in a painful sell-off that has lasted more than 4 months, so far. It’s even worse for the tech-heavy NASDAQ 100 which is down close to 30% since hitting its own record high in November last year.
Are we there yet?
Some analysts are warning that this sell-off could have further to go, pointing out that despite the decline so far this year, many individual equities and indices remain highly valued by many measures. Others say that while that is true, stocks which were in high demand a few months ago, are now significantly cheaper than they were and offer value by other measures. Are we close to a bottom? It’s certainly possible. After all, there’s a lot of bad news priced into global equities. Not only do we have the prospect of protracted hostilities between Ukraine and Russia, with the danger that the war envelopes NATO countries too, but this comes against a background of rising interest rates. The bond market is also in freefall as yields jump to their highest levels in many years. TINA (There Is No Alternative) has lost her allure. Investors do have choices. And one of those is to quit the market and stick cash in the bank – for now. But it may not stay there for too long. Central banks may be turning hawkish, but they’re unlikely to raise rates high enough to cover current rates of inflation. Global stock markets may be down and could go down further. But they’re certainly not out as a potential investment.
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