January saw challenging volatility as investors confronted an increasingly hawkish Federal Reserve and rising Russia-Ukraine geopolitical concerns. The standard measure of stock market volatility, the CBOE Volatility Index, saw its highest close in nearly a year.
The tech-heavy Nasdaq is now firmly in correction territory, down roughly 14.5% year-to-date and 17.5% from its high. Many pandemic-era winning stocks, a number of SPACs (an investment vehicle that has exploded in popularity since 2020), and recently IPO-ed names have also seen their share prices crater. While the S&P 500 Index had its worst month since March 2020 and briefly flirted with a correction, it bounced back upwards at month end.
In this note, we’ll cover some of the major drivers of the news and what might await as we head further into the year.
Unfortunately, the new year has refreshed geopolitical concerns. Russia has amassed roughly 100,000 troops on the Ukraine border and the situation has continued to grow more tense. The U.K. believes a Russian invasion is “highly likely,” and on a call with Ukrainian president Volodymyr Zelensky, President Biden warned that an attack was “virtually certain” once the ground froze over in February. Russia and Ukraine, however, are trying to downplay the situation, and President Zelensky has accused the U.S. of stirring up unnecessary panic.
On an economic level, if any spark ignites, energy prices could continue to soar. Russia is one of the world’s largest oil and gas producers, with the European Union relying on it for around a third of its gas. Natural gas in Europe is already trading at about five times higher than it did a year ago and roughly seven times higher than in the United States. Should Russia limit or cut off Europe’s supply, pricing pressures would get worse. Crude oil prices have also skyrocketed year-to-date, past $86 a barrel, and the tension of the Russia-Ukraine situation has not helped.
In short, if your energy bill is soaring, it might not just be because you’ve turned the heater up. The situation will obviously continue to unfold but depending on what happens, rising energy prices may be a reality—which may also impact the issue of inflation.
U.S. inflation hit 7% in December, its fastest increase since 1982. In response to rising prices and noting that it has “quite a bit of room to raise interest rates without threatening the labor market,” the Fed indicated it would raise interest rates as early as March for the first time in three years.
Expectations adjusted quite sharply to this news. In December, bond markets priced in three rate hikes for 2022; now, they’ve priced in upwards of five rate hikes this year. Depending on how the economy continues in the recovery, the Fed could still prove to be more aggressive, especially in the early phase of its tightening process. Already, Atlanta Fed President Raphael Bostic said the Fed could hike rates in March by a half-point, if needed.
These decisions aren’t necessarily bad (some would argue that they’re overdue): The Fed’s policy is being driven by positive economic data. For example, the U.S. announced its fastest annual GDP growth in 2021 since Ronald Reagan was president.
Beyond that, and importantly for investors, corporate earnings remain encouraging.
With the January pullback, Fed rate hikes are largely being priced into market expectations, and geopolitical worries may or may not end up having an impact on inflation and markets. Fundamentally, the economic backdrop remains sound and could persist well into 2023.
Continue to expect a moderation in growth after a rip-roaring 2021, given the pending (and, in our view, reasonable) scaling back of fiscal and monetary support for the economy. A bit of froth may have come out of the markets, but real interest rates are still historically low, and the outlook for corporate returns remains positive.
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The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The Nasdaq Composite is a market-capitalization- weighted index consisting of all Nasdaq Stock Exchange listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds or debenture securities. The Bloomberg Barclays U.S. Aggregate Bond Index measures the investment-grade U.S. dollar-denominated, fixed-rate taxable bond market and includes Treasury securities, government-related securities, corporate securities, residential and commercial mortgage-backed securities, and asset-backed securities.
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