For those of you that weren’t able to attend our webinar on recent stock market volatility, we thought we’d provide a follow-up with our thoughts. With that said, let’s get to the details.
The equity markets have struggled in the early days of the 2022 calendar year. The stock market has acted a lot more volatile relative to recent years. The questions we most often receive are: why is this taking place, and will it persist? Admittedly, both of these are great questions. We are not going to pretend to know what the future holds for the equity markets, but we do have a few thoughts as to why the market is off to a sluggish start.
1) Returns may have already been pulled forward.
• Since the start of 2019, the S&P 500 has averaged 26.1% per year. This is the 8th strongest three-year return for U.S. equity markets since 1926. For reference, there have been 94 3-year time periods and the average 3-year returns are 10.8% over the studied time period (1926-2021).1
• Without additional fiscal or monetary stimulus, it would be imprudent to believe that we could achieve similar returns over the next 12-18 months, which could be causing investors to react accordingly and reallocate assets to more conservative investments.
2) Federal Reserve Hawkish Tilt
• There is angst in the equity markets as to how aggressive the Fed is going to be with both Federal Reserve rate hikes and the reduction of bond purchases (taper). The latter is set to conclude in March 2022.
• The Federal Reserve Open Market Committee (FOMC) is set to conclude their next two-day meeting on March 16th. The markets are anticipating at least a 25 basis point rate increase, but some predict a 50 basis points hike2.
i. The threat of higher interest rates is causing stocks to be repriced using a higher discount rate -the larger denominator (interest rates) results in a lower present value of projected future growth of a company.
3) Elevated Inflation
• The Consumer Price Index (CPI) recently released their January results and the data showed a 7.5% year over year increase in prices3. This could negatively impact consumers and cause the economy to slow down.
• The elevated inflation readings and threat of more persistent inflation is what is causing the Federal Reserve to potentially become more aggressive with their rate hiking than what markets were pricing in late last year.
4) Geopolitical Issues
• RBC Wealth Management: Special Edition of Global Insight Weekly- Risks become realities: Consequences of Russia's strikes on Ukraine
• China is following a zero-Covid policy, which is reducing workers ability to work normal hours. This in turn reduces the amount of exports for the country and is a major contributor to the inflation growing around the world.
5) COVID-19 Omicron Variant
• Given what we have experienced over the last two years, we would be remiss not to include a line about Covid-19. Although the last few months have been challenging, we believe we are on the downswing from the recent Omicron surge which impacted not only consumers’ desire to go out in public, but workers’ ability to perform their duties. Thus we are faced with empty shelves, longer wait times for services, etc.
Although the volatility is uncomfortable to watch on a day-to-day basis, we don’t believe we are heading into a recession any time soon, and we still believe there are several positive factors that could extend this bull market further. Examples of those factors include strong corporate and consumer balance sheets, near record low unemployment rates and the shape of the yield curve, which is still upward sloping.
In sum, stock market volatility is not fun, but it is the price that investors pay for the potential for higher returns over the long term relative to more conservative asset classes. If it becomes too uncomfortable, please don’t hesitate to give us a call. We will always make time to address your concerns and review your accounts with you.