Here is an update from one of Manulife’s chief investment Strategists, Kevin Headland.

The start of 2022 hasn’t been kind to investors.  For example, the US stock market has suffered its worst start to the year since the global financial crisis, as the threat of rising interest rates, slowing corporate earnings growth and geopolitical tensions has sent stocks tumbling across the board. While investors have been weighing rising rates and slowing growth for months, the past few weeks have also added an additional complication: the threat of war in Ukraine. Geopolitical risks are notoriously difficult to price into stock markets, but rising tensions over a potential Russian invasion have helped to spread weakness from technology stocks to the broader market in the second half of January.

As of February 9th’s close, the S&P 500, S&P/TSX, MSCI Europe, MSCI EAFE and NASDAQ Composite price indices have returned -5.1%, 0.7%, -3.8%, -3.3%, and -9.3% respectively since the calendar changed to 2022.

What are the reasons for the market weakness? We believe that the majority of the change in sentiment towards risky assets in the short term can be tied to the uncertainty around the path of the U.S. Federal Reserve’s rate hikes. In a very short manner, the consensus now believes that the Fed will increase interest rates five times instead of two after last Friday’s very strong January U.S. employment data.

While the Fed has communicated that it’s likely to begin raising interest rates sooner than originally expected, we don’t believe this is a cause for concern. In our view, despite the short-term volatility that a pivot in monetary policy will create, it’s a positive development. The Fed is signaling that they no longer feel the economy needs the ultra-accommodative monetary policy implemented during the peak of the crisis in early 2020. They’re simply reducing the additional support. The Fed isn’t raising rates from a neutral posture but rather starting to move away from the zero bound. In the short term, markets tend to react negatively to the idea of the Fed taking away the proverbial punchbowl at the party, but this doesn’t mean the party is over. It implies the party won’t be as entertaining, but fun, nonetheless.

Higher growth companies that have benefited from low-interest rates to support their longer duration revenue streams are bearing the brunt of this shift in yields. “Don’t throw the baby out with the bathwater” comes to mind with the recent selloff as good quality businesses are getting caught up in the downturn. This can be explained in part by the increased adoption of passive vehicles. For example, the big three providers who account for nearly 80% of the U.S. exchange-traded fund (ETF) market collectively own about 22% of any typical S&P 500 company, up from 13.5% in 2008.

We’re also in the early stages of Q4 earnings season, and the market seems to be rewarding or punishing individual companies based on their announcements. It’s not just about Q4 results but also their forward guidance. Supply chain issues and elevated input costs are creating uncertainty for some companies over the next few quarters, and this is adding to some of the price pressure.

Geopolitical risk is also factoring into the market unrest, as renewed tensions between Russia and Ukraine, among others, top headlines. Geopolitics is always simmering in the background, but when there are flare-ups, we often see short-term market reactions. However, recent history shows that these are usually disruptive rather than destructive to the markets.

For the long-term investor, it’s important to remain focused on the fundamentals. Nothing has changed from our views.

We must take a step back during these pit stops and ask ourselves, “What are the risks of a recession over the coming year?” As the table below illustrates, when markets fall outside of recessions, the returns are quite strong one year later.

S&P 500 Price Index one-year forward returns after selloffs from 52-week peak1990 – current

Here’s a chart that compares S&P 500 Index one-year forward returns after selloffs from a 52-week peak. It shows the returns during periods of recession and non-recession, as well as all periods combined, from 1990 to 2021.

Source: Capital Markets Strategy, Bloomberg, as of December 31, 2021

There are usually leading indicators to a recession — the most prevalent is an inverted yield curve. Based on our list of indicators below, we currently only have one of the typical signs of a recession and, as such, we continue to believe recessionary risk in 2022 remains low. Since most bear markets coincide with recessions, we don’t anticipate this near-term market volatility to cause a significant decline from these levels.

Typical signs of a recession aren’t present

This is a table that shows the typical signs of a recession. Of the seven indicators in the table, only one is currently present: positive inflationary trends.

Source: Capital Markets Strategy, Bloomberg, as of December 31, 2021

We can also look at U.S. Conference Board Leading Economic Index (LEI) as an example of the health of the economy. The current level would suggest that the U.S. economy is in a stable position in 2022. Excluding the recent self-induced recession caused by the pandemic, since 1970, a recession and market peak occurred six months, on average, after the LEI became negative.

Conference Board Composite Index of Leading Economic Indicators

1960 – current

This chart shows the U.S. Conference Board Leading Economic Index levels from 1960 to 2021. The chart includes leading indicators, recession periods, and market peaks. In 2021, leading indicators hit an all-time high for the overall period shown and are currently positive.

Source: Capital Markets Strategy, Bloomberg, as of December 31, 2021

A correction is entirely possible in the near term, and recent strong equity markets can sometimes cause overconfidence. Some investors start to think they can time the markets — get out and in at the “right time.” What if they’re wrong? As the table below illustrates, in 2021, missing the best days in the market can have a meaningful impact even in the short term. Remember, it’s time in the market, not timing the market, that matters.

Value of staying invested — S&P 500 Price Index

2021 return profile under various scenarios

Here’s a chart that shows the value of staying invested in the markets. The chart is based on different scenarios for the 2021 S&P 500 Index return profile.

Source: Capital Markets Strategy, Bloomberg, as of December 31, 2021



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