January ushered in the first official market correction since the March 2020 pandemic bear market. A late rally wasn’t enough to prevent the major benchmark indexes from closing out one of the worst months since March 2020. Tech stocks were hit hard in January as investors pondered how rising interest rates might weigh on that sector’s pricey valuations. Despite a two-session, end-of-month rally of more than 6.5%, the Nasdaq remained firmly in correction territory, down 12% from its November all-time high and down 8.9% for January. The small caps of the Russell 2000 dropped more than 9.5%, while the large caps of the S&P 500 (-5.3%) and the Dow (-3.3%) slid lower.?
Stocks ended January lower as investors dealt with concerns over inflation, the prospects of rising interest rates, and the pace of global economic recovery. The start of the fourth-quarter corporate earnings’ season in January was positive but not as robust as in December. While the economy advanced at an annualized rate of nearly 7.0% in the fourth quarter, 2022 is expected to see a slowdown triggered by ongoing coronavirus disruptions and fading fiscal support. Escalating tensions between the United States and Russia offered further market agitation.
If you have not read our 2021 Market Commentary & 2022 Outlook, I encourage you to check it out. It contains our assessment of the market dynamics in play and an in-depth explanation not repeated here. The high-level summary is why we believe the economy will continue to grow relatively vigorously, though the pace of growth will likely slow. Still, a virtuous economic cycle is underway. And, because it is fueled by monetary stimulus and driven by strong consumer and corporate balance sheets, as well as solid corporate earnings, a high level of capital expenditures, and sound credit markets, it will continue. Expect turbulence as the Fed withdraws from the massive influence they have exerted on the economy and markets. Bonds are unlikely to deliver positive, real returns (inflation minus nominal yield), and stocks should deliver better real returns, albeit with higher volatility.
Hotter inflation and the reversal of Fed monetary policy appeared to finally take a toll on low rates in January. The US 10-year treasury note lifted off from the 1½% range it had been stuck in for the latter half of 2021. As of January 31th, the UST 10-year yield stood at 1.782%, notably returning to pre-pandemic levels.
The antecedent of the January correction appeared to be the release of the Federal Reserve’s December meeting notes which brought to light that the Federal Reserve is closely examining how to “run-off its balance sheet.” The Federal Reserve has been the whale buyer in the treasury bond and mortgage market. As a result, the Fed’s balance sheet size doubled since the beginning of the pandemic. It was $4.15 Trillion pre-pandemic and now sits at $9 Trillion.
The tapering of bond purchases, which is underway, means the Federal Reserve is withdrawing from the bond and mortgage market as a buyer. Running off its balance sheet means it will become a net seller by not reinvesting as bonds mature or are called and mortgages are refinanced or repaid. On January 26th, the Fed issued a press release titled, “Principles for Reducing the Size of the Federal Reserve’s Balance Sheet” offering high level information regarding their intention. Within the release and in interviews given by Federal Reserve committee members, it appears the Fed could become more focused upon removing their influence from the credit markets and, specifically, the mortgage market.
As the Federal Reserve continues to unwind from their emergency monetary posture, we expect market turbulence. Jeremy Siegel refers to this type of market choppiness as “Taper Tremors”. You may have noticed trade confirmations for purchases we recently made in your investment account(s). As described in our year-end commentary, we took the January correction as an opportunity to put “dry powder” (i.e. idle cash) to work by incrementally adding to the types of stocks we believe will perform relatively better in an inflationary and increasing interest rate environment. Specifically, we purchased positions that invest in companies with high free-cash flows with a tilt towards value and cyclical sectors.
Your January month-end portfolio reports have been deposited in your eMoney vault, and we are reaching out to offer review meetings. If you want to schedule a review sooner, please contact us with dates and times that work well for you, or you may self-schedule here.
Thanks,
Tim
