Investment Focus | Issue 12 | What’s causing the recent market volatility and selloff?
The first few weeks of 2022 have not been kind to investors. In fact, it’s been the worst January for almost 30 years. While the Canadian market (S&P/TSX) is only down 3% year to date, the US market has fared much worse with the S&P 500 down 9% and the Nasdaq down 15%. International markets have fared similarly.
What are the reasons for this correction? Much of the volatility is tied to the start of central bank interest rate increases around the world. The US Federal Reserve and the Bank of Canada will begin increasing rates to prevent inflation from rising further. The market volatility is mainly due to the uncertainty around when these hikes will happen. Originally the market had priced in 2 rates hikes this year in the US, but the consensus now favours 4 rate hikes for 2022. This resulted in a 32-basis point jump in the US 10-year treasury yield. This is an issue because rate hikes can cool economic expansion and make borrowing more expensive. They also depress the value of your fixed income funds and the future earnings of companies (especially tech companies).
Besides the rate increases, we are also dealing with global supply chain issues which is creating uncertainty for some companies, and this is adding to some of the price pressure. Add to this the geopolitical risk with tensions between Russia, Ukraine, and the West.
Although this has caused a flight from “risky” assets, we don’t believe this is a cause for concern. If the Bank of Canada and the US Federal Reserve increase rates, this is a positive development. It means that the economy no longer needs the support of accommodative monetary policy or lower interest rates. When across the board market corrections happen like this, all companies are caught up in the selling frenzy, regardless of their quality. As a result, this provides opportunity for managers to buy quality companies at a discount.
Should I be concerned?
For the long-term investor, it’s important to remain focused on the fundamentals during times like these. With the exception of inflation, the red flags that are typical leading indicators of recessions are not present.
Historically, equity markets experience a 10% pullback, in two out of every three years (source: Bloomberg). Moreover, historical data also illustrate that in the three months before and after the first Federal Reserve rate hike (of a given rising-rates cycle), it is typical over this six-month period to have a 10% pullback in stocks. However, investors who stand pat during and after such a period of volatility could benefit, as stocks on average have gained 7% in the six months following this first rate hike, and 12% in the 12 months after.
We expect to see more market volatility in the weeks ahead. While it can often be difficult during times like these, staying the course is usually the best solution. We encourage investors to remain disciplined, as in our opinion, the volatility is temporary. If you have any concerns about the market or your portfolio during this time, please reach out to us.
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