Key Points:
- Stocks sold off to start 2022 as the major US averages dropped between 3 and 9%, with riskier stocks detracting most.
- Higher inflation has the Federal Reserve prepared to complete their asset purchases and raise interest rates in the coming quarters.
- The global economy is expected to continue to grow in 2022, but at slower rates from last year.
After a strong and rather calm year in equities during 2021, stocks pulled back aggressively to start 2022. Elevated valuations, high inflation and geopolitical tensions forced investors to reprice risk in the markets. The technology heavy NASDAQ Composite Index lost 8.96% in January, with high growth/no earnings companies seeing the biggest losses. The higher quality market indexes fared better, with the S&P500 dropping 5.17% and the Dow Jones Industrial Average losing just 3.24%. Energy stocks (+19.10) and financials (+0.06%) were the only positive sectors of the S&P500 while consumer discretionary (-9.68%) and real estate (-8.5%) saw the biggest selloff. Value stocks held up relatively well with the Russell 1000 Value down 2.33% vs. an 8.58% loss for the Russell 1000 Growth. Small cap stocks dropped 9.63% to star the year, with value outperforming growth.
Globally diversified investors benefitted from international markets holding up relatively well. Developed international markets as measured by the MSCI EAFE index dropped 4.83% while emerging markets lost just 1.89% (MSCI EM Index). Latin American equities were down over 8% in 2021 but were the lone bright spot in January gaining over 7%. Stock valuations outside the US remain relatively lower and thus could be less vulnerable to further selloffs this year.
Uncertainty over the pace of interest rate hikes from the Federal Reserve rattled the bond market in January. The yield on the 10-year Treasury note climbed from 1.51% at the end of 2021 to 1.78%, reflecting investors’ concerns over inflation and future interest rate increases. The Bloomberg US Aggregate Bond index fell 2.15%, while riskier high yield bonds fell further. Asset backed securities (-0.56%) and mortgage backed bonds (-1.48%) held up the best in US markets. Despite the losses in the bond market, yields are moving higher and becoming more attractive to fixed income investors.
While January was a difficult month to remain invested, it is important to remember that on average markets correct 10-15% every 12-18 months. We had not experienced a correction since the first quarter of 2020, so markets were probably overdue. Corporate balance sheets remain strong, the US consumer is in good shape, but investors must recognize that 2022 will likely continue to be a bumpy ride. Higher interest rates mean that the US economy is growing and is healthy. The Federal Reserve needs to remove accommodative measures to keep inflation in check and have flexibility for the next time it needs to provide liquidity. While the economy will begin to slow this year compared to last, the probably of a recession in 2022 remains low.
Sources: Morningstar Direct, Wall Street Journal, First Trust