Why New Years mayhem may signal a more balanced — but volatile — stock market in 2022 as investors grapple with a hawkish Fed

Santa Claus had barely hung up his boots after delivering his eponymous rally to good small stock investors, when all hell broke loose.

The market swung sharply last week as investors rang the bell in the first week of trading in 2022, and market watchers pointed to the prospect of greater volatility as they grappled with it. the ability of the Federal Reserve to fight inflation without pushing the economy into recession.

“I think the markets are trying to determine how aggressive the Fed will be in removing accommodation and tightening and whether it will eventually make a policy error,” said Ed Keon, chief investment strategist at QMA, during ‘a telephone interview.

The release of the minutes of the Federal Reserve’s December 14-15 policy meeting on Wednesday fueled uncertainty. They revealed that policymakers discussed being more aggressive in raising rates than expected and raised the possibility of starting to shrink the size of the Fed’s balance sheet faster than they did when they did. they ended a previous round of quantitative easing spurred by the financial crisis.

This fueled a massive sell-off in the bond market which saw the performance of the 10-year T-bill TMUBMUSD10Y,
1.767%
jump of more than 27 basis points, or 0.27 percentage point, over the past week, the largest such increase since September 2019. At 1.769%, the rate is the highest since January 17, 2020 .

Before the minutes, the Dow Jones Industrial Average DJIA,
-0.01%
and had risen 2.4% in the last five trading days of 2021 and the first two of 2022 – the stretch that defines the so-called Santa rally. For the Dow Jones, this is the strongest increase in the seasonal phenomenon since 2008-09, when it increased by more than 6%. The S&P 500 SPX,
-0.41%
won 1.4% thanks to St. Nick, his strongest such race since 2012-13.

But the surge in yields did not favor tech stocks and other rate-sensitive growth stocks, which had already started to suffer last month. The highly technical Nasdaq Composite COMP,
-0.96%
had completely missed the Santa Claus rally, down 0.2%. On Wednesday, he lost more than 3% for his worst one-day performance since February.

Valuations of growing companies are based on expected long-term cash flows. Higher interest rates mean that money is not as valuable as it was when rates were lower.

The Dow and S&P 500 also suffered, and the three major indexes ended the week with losses, although the Dow and S&P 500 remain just 1.5% and 2.5% of the record highs set respectively. January 4 and 3. Crypto traders also appeared shaken by the minutes, with bitcoin BTCUSD,
-0.86%
sliding to a three-month low, leaving the world’s largest digital asset with its worst start to a calendar year since 2014.

Value stocks beat their growth counterparts in the first week of 2022, extending the outperformance seen in December. The Russell 1000 Value RLV Index,
+ 0.23%
rose 0.8% over the past week, while the Russell 1000 Growth RLG Index,
-1.09%
fell 4.8%, according to FactSet data. In December, the Russell 1000 Value Index climbed 6.1%, for its biggest monthly gain since November 2020, to overtake the 2.1% advance of the Russell 1000 Growth.

Read: Value stocks have led growth in recent weeks. Is it a false head?

At the sector level, technology fell 4.7% over the past week, while high-value cyclical sectors surged, noted Brian Levitt, global markets strategist at Invesco. Financials jumped 5.6%, while energy jumped more than 10%. And the defensive consumer staples sector managed to rise about 0.4%.

That doesn’t mean investors should rush to chase rotation, he said in a note.

“Basically we are seeing the Fed pulling the brakes, guiding interest rates up and flattening the yield curve to contain an overheating US economy. Against this backdrop, we believe it is too early to turn to cyclical, high value-added stocks, which would likely require a steepening of the yield curve and an economic re-acceleration, ”said Levitt.

In the absence of an economic recession, now is also probably not the right time for investors to focus on defensive stock sectors, he said, as they are unlikely to significantly outperform until. at the end of the current market cycle.

QMA’s Keon doesn’t expect the Fed to do too much, but warns that this is a sizable risk as policymakers grapple with the inflationary consequences of a $ 5 fiscal stimulus. Trillion dollars and the central bank’s own aggressive actions on the monetary policy front.

Shifting from an environment of flowing liquidity to one in which policymakers turn off the taps and drain liquidity does not preclude positive returns for stocks and other risky assets, he said, but it does. You don’t have to be bold to expect more moderate gains after the S&P 500 posted annual price increases of 28.9% in 2019, 16.3% in 2020 and 26.9% in 2021.

For his part, Keon expects inflation to ease as supply chain bottlenecks ease. Economic growth could hiccup in the first quarter due to the omicron variant, improving in the second quarter as investors wait to determine what is sustainable for the end of 2022-2023.

Rising yields aren’t necessarily negative for stocks – after all, a stronger economy should lead to higher rates – but they are a stronger relative headwind for growth stocks. Keon said he didn’t expect value to “crush” growth in the coming year, but that the stage might be set for a more “balanced” market, rather than a market. marked by narrow leadership.

A much smaller than expected increase in non-farm payrolls on Friday did nothing to ease the upward pressure on yields, with investors instead focusing on an unemployment rate that unexpectedly fell to 3. 9% vs. 4.2%, while average hourly earnings showed a sharp increase.

“A 4.7% gain in annual hourly earnings, coupled with a drop in the unemployment rate to a new pandemic low of 3.9%, is a clear sign of a tight labor market if ever there is one, and likely give the Fed a slight green for monetary tightening, ”said Seemah Shah, chief strategist at Principal Global Investors, in comments sent via email.

See: Traders, little discouraged by disappointing job gains in December, continue to anticipate an “increasingly rapid” tightening by the Federal Reserve

The December jobs report “is not going to dampen bond yields, and the payroll figures are not strong enough to reassure markets about a very strong economy,” Shah wrote. “The stock markets are on the line for a volatile month.”

The coming week, meanwhile, is expected to fuel volatility, with the economic calendar showing December’s consumer price index reading Wednesday, December’s producer price index on Thursday, and December’s retail sales. and the latest reading from the University of Michigan Consumer Sentiment Survey. Friday.

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