Stock market starts worst since 2016 as Fed faces inflation

After falling for a fourth straight day on Friday, the stock market had its worst week in nearly two years, and so far in January, the S&P 500 has had its worst start since 2016. Technology stocks have been hit particularly hard, with the Nasdaq Composite Index falling more than 10% from its most recent high, seen as a correction in the Wall Street discussion.

That’s not all. The bond market is also in turmoil, with interest rates surging and bond prices, in the opposite direction, falling. Inflationary red hot, and supply chain disruption continue.

So far, the markets have looked at such issues during the pandemic, which has brought about massive increases in the value of all asset classes.

However, one key factor has changed, which has led some to watch the market reason to worry that the recent drop may be the result. That factor is the Federal Reserve.

As the worst economic devastation of the pandemic appears to be waning, at least for the moment, the Fed is moving back into higher interest rates. It also started withdrawing some of the other forms of support that have kept the stock flying since it intervened to save severely damaged financial markets back in early 2020.

This could be a good thing if it pushes inflation back without derailing the economic recovery. But the removal of this support will certainly also cool the market as investors move money around, looking for assets that perform better when interest rates are high.

“The Fed policies have essentially started the current bull market,” said Edward Yardeni, an independent Wall Street economist. “I don’t think they’re going to end it all now, but the environment is changing and the Fed is responsible for a lot of this.”

The central bank is tightening monetary policy in part because it has worked. It helped stimulate economic growth by keeping short-term interest rates close to zero and pumping trillions of dollars into the economy.

This easy cash flow also contributed to the rapid increase in the price of goods, as food and energy, and Financial assets, like share, bonds, houses and even electronic money.

What happens next comes from a pre-established book. As William McChesney Martin, former Fed chairman, said in 1955, the central bank found itself acting as the adult in the room, “who gave orders to remove the punch bowl as soon as the party really heated up.”

Mr. Yardeni said the mood of the market changed on January 5, when Fed officials announced minutes in their December policy-making meeting, revealed that they are on track to adopt much tighter monetary policy. A week later, new data shows Inflation escalates to a 40-year high.

Take the two together, and it looks like the Fed will have no choice but to react to rein in rapidly rising prices. Stocks began to fall in a chaotic manner.

Financial markets now expect the Fed to raise interest rates at least three times this year and to begin shrinking its balance sheet as early as this spring. It has reduced its bond purchases. Fed policymakers will see you next week to decide their next steps and what market strategists will watch.

Low interest rates make certain sectors particularly attractive, the most prominent of which is technology stocks. The S&P 500 information technology sector, which includes Apple and Microsoft, has gained 54% on a year-on-year basis since the market’s pandemic low in March 2020. One reason for this is interest. Low yields amplify the value of the expected future profits of growth-oriented companies like these. If the rate rises, this calculation can change suddenly.

It is the prospect of higher interest rates that has made technology the worst performing sector in the S&P 500 this year. Since peaking in late December, it has dropped more than 11%.

On the other hand, the three best performing S&P sectors in the early days of 2022 are energy, financial services, and consumer staples.

The energy index is dominated by fossil fuel companies, such as Exxon Mobil and Halliburton, whose fortunes rose along with oil and gas prices. Finance companies may charge extra fees for loans when interest rates are high. Big banks like Wells Fargo have reported bumper earnings over the past week. Consumer companies like Kraft Heinz and Campbell Soup have lagged the explosive share price growth of tech stocks earlier during the pandemic, but they have been gaining ground in this new environment. .

In general, the stock market has also lost some of its buoyancy for reasons other than monetary policy. Stay-at-home stocks thrive during pandemic restrictions, like Netflix and Peloton, started flagging as people explored more.

Some astute market analysts foresee bigger problems. Jeremy Grantham, one of the founders of GMO, an asset manager, guess a catastrophic end to what he calls a “superb”.

But current losses can be beneficial if they break out of the potential bubble a bit without rupturing an investor’s portfolio. This year’s drop has erased only a fraction of the market’s gains in recent years: The S&P 500 is up nearly 27% last year, more than 16% in 2020 and almost 29% in 2019.

And the company’s earnings outlook remains good. Once the Fed kicks in and the effects are better understood, the stock market could move on — at a less hilarious pace.