2021 was a good year for US stock markets and the S&P 500 had its third consecutive year of double-digit returns. In terms of risk-adjusted performance, it was among the best years with low volatility and high returns.
However, it has been a perfect storm of sorts for US stock markets in 2022. While markets are down on a YTD basis, volatility has been quite high. More than the negative price movement, it’s the steep rise in volatility that looks concerning. Why are stocks so volatile in 2022 and what lies ahead?
It has been a perfect storm for US stock markets
As we entered 2022, high inflation and fears of Fed rate hike, slowing and uneven growth, and geopolitical tensions were the biggest threats. All these risks have played off in possibly the worst possible fashion. US inflation has been hitting new records and was an annualized 7.5% in January. The 10-year US bond yield spiked above 2%, a reflection that the market expects the Fed to act quickly to tame rising prices.
On the geopolitical front, Russia-Ukraine tensions have heated up. While French President Emanual Marcon said that Russian President Vladimir Putin has assured him that Russia would not escalate tensions, at least the White House is not convinced. The US has asked its citizens to leave Ukraine, a sign that the country now sees Russia’s invasion of Ukraine as imminent.
As expected, energy prices spiked following the escalating tensions at the Ukraine-Russia borders. Crude oil at $100 per barrel is no more a pipedream and prices might rise even higher in case of a full-fledged Ukraine-Russia conflict.
Like every earnings season, even the fourth quarter 2021 earnings season had its own hits and misses. According to data from FactSet, 72% of the S&P 500 companies have reported their earnings. 72% of these companies posted positive EPS surprises which looks encouraging. However, what catches the eye is the fact that 47 companies issued negative EPS guidance while only 17 reported positive EPS guidance.
Notably, several companies including Meta Platforms, PayPal, Netflix, and Lyft provided a tepid outlook for the first quarter. Fears of slowing growth of US tech giants have amplified amid the mixed earnings season.
Over the last few weeks, corporate earnings were the key driver of the US stock markets. At least for this week, macro factors, including the noise over rate hikes and geopolitical tensions would drive markets.
Fed rate hikes
A March rate hike now looks like an almost done deal. What has been concerning though is the quantum of the hike as many observers now believe that the Fed would raise by 50 basis points instead of 25 basis points. St. Louis Fed President James Bullard has called for rates at 100 basis points by July. US stock markets, especially the tech stocks have sold off amid fears of aggressive tightening by the Fed.
Brokerages also expect the Fed to raise rates multiple times in 2022 and both Goldman Sachs and Bank of America now see as many has seven rate hikes in the year. Red hot inflation has been a worry for Fed officials as well as the Biden administration, especially as the midterm elections approach.
US stock markets have been quite volatile
Earnings, inflation, and geopolitical tensions have added to the volatility in US stock markets. We could see more volatility this week as the minutes of the Fed’s meeting are released this week. Stocks had sold off after minutes of the Fed’s December meeting were released. The minutes were more hawkish than expected and led to a broad-based sell-off in US stock markets.
This week would also be crucial on the geopolitical level as we will get some more clarity on Russia’s intentions amid the massive build-up of troops at the border with Ukraine.
Marc Chandler, chief market strategist at Bannockburn Global Forex said, “Up until now, I’d say it was all about monetary policy. This throws an extra unknown into the works.” He added, “The dollar is rallying, oil prices have rallied and stocks are selling off… Even if nothing happens this weekend, people will be nervous about it in the next week.”
Analysts expect US stock markets to remain volatile this week
Patrick Palfrey, senior equity strategist at Credit Suisse said that “I think volatility remains elevated as we transition from essentially this more dovish Fed to this more hawkish Fed policy which we’re experiencing.”
He added, “We haven’t yet settled on how hawkish we are going to be and until we can chart a new path for interest rates hikes with some consistency, I think volatility is going to remain elevated, and that’s going to be more true for high valuation companies.”
US stock markets might fall
While a Russian invasion of Ukraine could pump commodities like aluminum and energy, US stock markets could see a sell-off. “Its conceivable equities see another pullback in the 10.0% range as investors sell first and ask questions later. Growth and defensives will likely outperform initially, yet we suspect value and cyclicals are best positioned for the global cyclical recovery,” said John Lynch, chief investment officer at Comerica Wealth Management.
Lynch advised investors to stick to their long-term investing style amid the near-term volatility in stock markets.
Some of the stocks have started to look attractive amid the correction in US stock markets. While markets might come down further amid the current pessimism, it could be a good strategy to add quality stocks at these levels.
How to buy stocks for the long term?
Over the long-term stock markets are the best asset class. While 2022 might not be as fruitful for investors as the preceding three years, investors should do a rebalancing and maintain the desired exposure to equities.
For more information on trading in stocks, please see our selection of some of the best online stockbrokers. If you wish to trade derivatives, we also have reviewed a list of derivative brokers you can consider.
Also, if you are not well equipped to research stocks or want to avoid the hassle of identifying and investing in stocks, you can pick ETFs that give you diversified exposure to different themes.
By investing in an ETF, one gets returns that are linked to the underlying index after accounting for the fees and other transaction costs. There is also a guide on how to trade in ETFs.