Well, that happened fast. Coming into the year, consensus was that times were changing, and volatility was coming. As the world begins to look past the pandemic, it was widely expected that the stance of central banks would turn from dovish to hawkish and be less market friendly. That change didn’t take long.
Most of the selling was focused on higher multiple growth stocks. As rates move higher, multiples should compress. You don’t have to look further than the charts of everyone’s favourite pandemic winners: Peloton, Zoom, and Netflix—all are off over 50% from their recent highs.
Last year’s meme stock craze and SPAC boom seems like another world ago. It’s fitting that Robinhood, the company most responsible for this crazy period of trading, has seen its stock fall almost 90%, from $85 last summer to $10 this month.
But the sell-off didn’t end there. Aggressive selling took down last year’s winners across all sectors. It seemed many had held off selling until the new year, and after two years of double-digit gains, all the sellers ran for the exit at the same time.
The primary reason for this correction will be blamed on the FOMC. Policy error from central banks is always considered one of the greatest risks to financial markets. Whether they should have hiked interest rates last year or if quantitative easing should have ended sooner will be debated for years but with inflation at 40-year highs, it’s well understood they are behind the curve.
The bond market has been signalling these concerns for a while. Most of the focus is on the 10-year bond yield, but the real excitement has been in the shorter end. The U.S. 2-year bond yield has moved from 0.2% last summer to 1.2% this month. This hasn’t caused an inversion of the yield curve yet but has flattened it for sure.
The hawkish tone that came from the FOMC in the January meeting has moved market expectations to five hikes and the beginning of quantitative tightening (running off the balance sheet) by the end of 2022. This is much more aggressive than expectations even a few months ago.
But now we have to ask: have we gone too far the other way? China is already starting to cut rates to deal with problems in its property market. Supply chains are opening, which may prove prices increases were transitory all along. This will be debated all year. Regardless of the answer.
Going forward, every economic data point will be important to monitor. Every central bank meeting will be “live,” meaning they could hike. It’s not a time for investors to be complacent.
Tactically, the question will be if it’s time to check for a bottom. Did we get the capitulation we need to wash out the speculative excess of last year?
From a contrarian point of view, we’re getting some great signals, as bearish sentiment is now at a level not seen since the 1990s. It’s amazing how quickly everyone went from max bulls to max bears.
There remains a mountain of cash on the sidelines that must be deployed. Recent earnings announcements show that companies are adapting to the new challenges and remain profitable. Most importantly, there are no signs of a recession on the horizon.
As fast as the selling hit, it may go away—equity markets seem short-term oversold—but the tone of the market has definitely changed. The playbook that worked so well the past few years must be thrown away. It doesn’t mean it’s time to hide; it’s just time to adapt to the new environment.
— Greg Taylor is the Chief Investment Officer at Purpose Investments
Sources: Charts are sourced to Bloomberg L.P.
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