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Volatility:  Our 2022 Road Trip Just Started - Did We Get a Flat Tire Already? Thumbnail

Volatility: Our 2022 Road Trip Just Started - Did We Get a Flat Tire Already?

The start of 2022 hasn’t been kind to us as investors. As of Friday Sept 21st, early afternoon, the Dow Jones Industrial Average, S&P 500, and NASDAQ Composite price indices are down approximately 5%, 7%, and 11%, respectively since the calendar changed to 2022. The NASDAQ has also fallen into correction territory, as it is down more than 10%.  What are the reasons for the market weakness?  We believe that the change in sentiment can be tied to the uncertainty around the path of the U.S. Federal Reserve’s rate hikes.  The consensus now believes that the Fed will increase rates four times instead of two to fight against elevated levels of inflation. That has resulted in a 32-basis point jump in the U.S. 10-year Treasury yield.  The Canadian market looks similar.  

While the Fed has communicated that it’s likely to begin raising interest rates sooner than originally expected, we don’t believe this is a cause for concern.   In our view, despite the short-term volatility that a pivot in monetary policy will create, it’s a positive development. The Fed is signaling that they no longer feel the economy needs the ultra-accommodative monetary policy implemented during the peak of the crisis in early 2020. They’re simply reducing the additional support. In the short term, markets tend to react negatively to the idea of the Fed taking away the proverbial punchbowl at the party, but this doesn’t mean the party is over. It implies the party won’t be as entertaining, but fun, nonetheless.

Higher growth companies that have benefited from low interest rates to support their longer duration revenue streams are bearing the brunt of this shift in yields. “Don’t throw the baby out with the bathwater” comes to mind with the recent selloff as good quality businesses are getting caught up in the downturn. This can be explained in part to the increased adoption of exchange-traded funds (ETFs). For example, the big three ETF providers who account for nearly 80% of the U.S. exchange-traded fund (ETF) market collectively own about 22% of any typical S&P 500 company, up from 13.5% in 2008.1

Other contributors to the uncertainty include supply chain issues, creating uncertainty for some companies over the next few quarters, adding to some of the price pressure.

Geopolitical risk is also factoring into the market unrest, as renewed tensions between Russia and Ukraine, among others, top headlines. Geopolitics are always simmering in the background, but when there are flare-ups, we often see short-term market reaction. However, recent history shows that these are usually disruptive rather than destructive to the markets.

For the long-term investor, it’s important to remain focused on the fundamentals. Nothing has changed from our views.  We expect some pit stops along the way during our road trip this year, as we did last year in both January and October.  This one just came a little earlier than anticipated.  

 

“What are the risks of a recession over the coming year?” 

There are usually leading indicators to a recession — the most prevalent is an inverted yield curve. Based on a list of indicators below, we currently only have one of the typical signs of a recession and, as such, we continue to believe recessionary risk in 2022 remains low. Since most bear markets coincide with recessions, we don’t anticipate this near-term market volatility to cause a significant decline from these levels. 

Typical signs of a recession aren’t present

Source: Capital Markets Strategy, Bloomberg, as of December 31, 2021

 

How will this look going forward? 

Here is the good news.   As the table below illustrates, when markets fall outside of recessions, the returns are quite strong within a short period of time. 

S&P 500 Price Index 1-year forward returns after selloffs from 52-week peak (1990 – current)

Source: Capital Markets Strategy, Bloomberg, as of December 31, 2021

In summary, we do not think this is anything further than a normal correction.  It is painful, they always are, but we do not believe markets will be negative for a prolonged period.  With underlying strength in the economy and a lack of typical recession signals, we think this will be short term pain.

As always, we are happy to talk about it.  


Manulife Investment Management January 21, 2022