Market Musings 29/01/22:
Navigating between the Fed’s Scylla and Russia’s Charybdis
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Summary:
- Stock markets continue to suffer a correction, the first since 2020.
A reminder that stock market volatility and 10% corrections are normal, even during long-running bull markets. - Twin key risks for economies, markets:
- that the US Federal Reserve central bank applies the brakes too hard by raising rates and reducing their balance sheet just as growth is already slowing.
- Russia massing troops on the Ukrainian border in preparation for invasion. - Investor greed has turned to fear; but we have not seen widespread capitulation by retail investors as judged by investor fund flows.
- Corporate earnings trends remain strong, as is economic momentum in Europe (for now).
- A good reason to favour UK and Europe over the US, given ongoing risks to US tech stocks.
- US small-caps are already in a bear market… As are non-profitable tech stocks, biotech, Russian stocks,
- I watch for entry opportunities in: Commodity-related sectors (Oil & Gas, Mining), biotech and healthcare, selected tech subthemes (cybersecurity, e-payments, semiconductors), discounted investment trusts
Market correction deepens post Fed
The relatively tough talking by US Federal Reserve President Jerome Powell at last week’s Federal Reserve committee press conference sent shivers through financial markets.
As a result, economists of various investment banks have rushed to increase their forecast of the number of times that the Fed will raise interest rates this year, with some banks forecasting as much as 6 interest rate hikes (taking the Fed Funds interest rate from 0% today to 1.5% by end-2022).
As always, the risk to financial markets when the Fed begins to raise interest rates in an effort to combat high inflation is that they overdo it, in the process killing growth and sending the economy into recession.
For stock markets, recession is always a painful experience as corporate profits shrink and as investors rotate out of stocks into safer assets such as government bonds, which tend to outperform during recessions as inflation falls (along with growth).
These fears have translated into a 13% drop in the Nasdaq index since the start of this year, with many growth stocks doing far worse than this.
Nasdaq -13%, global stocks -7% since start of the year
Source: BNP Paribas, Bloomberg
But in…
