By: Jeff Anderson, CFA
This Week: It was another volatile week for domestic equity markets. The Nasdaq 100 dropped roughly 7.5% for the week, its worst week since March 2020. It has lowered 14.2% from its November 2021 high. Historically, markets correct between 10% and 20% every 22 months (source: First Trust Advisors, L.P.). Therefore, the markets were due for a correction. As investors digested the likelihood of rate hikes coming as soon as March 2022, they have rotated out of growth stocks and into value-oriented companies.
Higher interest rates, persistent inflationary pressures and the Omicron variant’s less-than estimated effects on the economy allowed Crude Oil to finish slightly higher on the week, closing at $84.79 a barrel.
|Close||Weekly return||YTD return|
|US Treasury 10yr Yield||1.763%|
Source: Wall St. Journal
- Market Update
- The Fed’s Playbook
- Netflix, Peloton and the Curse of The Re-Opening Trade
The Fed’s Playbook
Historically, the drumbeat from Wall Street has been to avoid conflict with the Federal Reserve. As the Fed recently embarked on multiple Quantitative Easing programs, investors have realized that equities are the direct beneficiary from a wall of liquidity provided by the Fed.
Fed Governor, Jerome Powell, is still battling inflation, as it has persisted far longer than he originally estimated. In December of 2021, the fed futures priced in one to two rate hikes for 2022. However, since the CPI clocked in at 7% for 2021, Mr. Powell has set an aggressive course to taper the Fed’s bond purchasing program to rein in inflation with multiple rate hikes in 2022.
A “less” accommodative Fed has led to market volatility, with growth stocks taking the brunt of the sell-off. The Fed essentially has three levers: to stop purchasing assets (mainly government bonds), increase interest rates, and reduce its balance sheet. The Fed reducing its balance sheet affects the market liquidity the most. Currently, there are no plans to reduce the Fed’s nearly $9 trillion balance sheet, which would keep the Fed accommodative, from a historical perspective. If rate hikes and improvements in supply chain disruptions ease inflationary pressures, the Fed could return to a dovish positioning, allowing equity markets a boost later this year. If the Fed overshoots, the economy could weaken, and Mr. Powell could use that cue to reverse course. Mr. Powell has proven to be more flexible and reactive than previous Fed governors. We shall see.
Netflix, Peloton and the Curse of The Re-Opening Trade
The financial media coined it the “stay-at-home-trade.” Companies that originally benefited from people forced indoors and ordered to work from home during the pandemic, saw their share prices swoon recently. In the beginning quarters of the pandemic, investors considered companies like Netflix, Zoom and Peloton, leaders in a new way of living.
As the economy re-opened, the “stay-at-home trade” has lost momentum. In some cases, like Peloton, companies simply over-estimated demand for their products in a post-pandemic world. The pandemic effects were so acute and new that many investors overestimated the durability of the growth prospects of these companies. In the short term, markets can be brutal. In the long term, companies will adjust, and their stock prices will eventually reflect a normal economic environment.