by Franklin J. Parker, CFA
- Treasury yields continue to rise, this morning standing above 1.8%—a move of 0.40 percentage points in the space of a few weeks. This has put considerable downward pressure on high-flying tech stocks, and since tech is also a large component of the S&P 500, it has begun to weigh on stocks, generally. With rates moving higher, capital will be more precious, leaving many companies who have been reliant on cheap capital struggling to find additional funding. This is a long-term good, in my view, as it forces companies to deliver value and turn a profit rather than count on investors to continue funding shortfalls. Companies unable to do this will release their resources to companies who can.
- Employment was the headline news from last week, with the unemployment rate dropping below 4% for the first time since the pandemic began (and the overall figures in the report were quite positive). This is an important milestone and will be likely taken by the Fed as encouragement to act aggressively to curb inflation. The important news for investors, however, was the FOMC minutes that were released. In the minutes it appears that the committee is considering raising rates much faster than previously anticipated. Indeed, the March meeting is now considered “live” for a rate increase. This puts the Fed’s stance as much more hawkish than previously thought.
- This week, we get inflation data for December, both in the form of the consumer price index (CPI), and the producer price index (PPI). CPI is expected to post around 7% higher year-over-year (slightly higher than November’s reading of 6.8%). PPI is expected to be about 9.8% higher year-over-year (previous was 9.6%). Of course, inflation readings are the core driver of Federal Reserve policy and will be watched very closely.
- As I have mentioned before, I am cautious with respect to the first half of this year. It has been my view that we could easily see a 15% to 20% pullback in large cap US stocks (likely more in small and growth companies). My view is that this is likely to begin in earnest after earnings season, but now may be an appropriate time to grow more defensive for investors with goals in the near future. For investors with cash to deploy, I would prefer to hold that cash in reserve, to deploy during the pullback. Of course, there is a risk to such a strategy—the correction may not materialize. As I have also said before, I do not see this as the end of the cycle, so for investors with longer-term goals, there is nothing wrong with holding on and riding this one out since the risk of losing upside is greater than the risk of some short-term downside. Of course, this is best discussed with your financial professional. If you don’t have one, please contact us, we’d love to talk with you.
There has been quite a lot made of the rise of the retail trader, from meme-stocks to cryptocurrencies. I spoke with a friend of mine (and fellow NAAIM award-winner) last week about how retail traders following meme-stocks and random cryptocurrencies have outperformed professionals who are concerned about the risk pervading markets right now.
In many ways, this dichotomy is a symptom of the easy-money policy of the Federal Reserve. Professionals are obsessed with managing and weighing risk (upside risk and downside risk), and for the past several years, Fed policy has pulled downside risk out of markets, leaving professionals behind.
That is, now, beginning to reverse. I see 2022 as a transitional year. For the first part of the year, the Fed will carry an outsized influence, mostly weighing on markets as investors normalize their pricing. Toward the back-half of the year, however, we are likely to return to an environment where economic fundamentals matter again. For me, that is encouraging because economic fundamentals are what drive long-term, sustainable economic growth, and they are indicative of much more traditional kinds of investment risk that I am comfortable managing.
In the end, risk control does matter. As the tide goes out, we may well see who is swimming without a bathing suit.
Chart of the Week
Since mid-October or so, US Treasury yields have been range-bound between 1.35% and 1.70%. Last week, yields on the 10-year broke that critical 1.7% resistance level and have been on a firm move higher. This is putting downward pressure on bonds as well as growth stocks. Analysts estimate that there is still considerable room to run for yields. JPMorgan, for example, expects the 10-year to reach 2.25% by year-end.
As with any market move, there are winners and losers. While growth stocks (and tech in particular) are likely to struggle, bank stocks (especially smaller regional banks) are likely to benefit from higher yields and a steeper yield curve. Investors would do well to note the rotation and accommodate it in their portfolios.
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