The US stock market has had its worst start to the year since the global financial crisis, as the threat of rising interest rates, declining corporate earnings growth and geopolitical tensions caused equities to tumble across the board.
The S&P 500 index fell 5.3 percent in January, the largest monthly decline since the onset of the coronavirus pandemic in March 2020 and the weakest January since the depths of the global financial crisis in 2009.
The blue-chip benchmark had been on track for even worse performance – last week it approached the worst January ever – until a 4 per cent recovery in the month’s last two trading days on Friday and Monday.
But despite ending on a firmer footing, investors are preparing for more volatility.
For example, the managers of the fund manager Franklin Templeton’s multi-asset division usually meet once a month to adjust how much they allocate to different types of assets. But they decided to start meeting weekly to make sure they could respond quickly enough to volatility.
“It’s going to be that type of year – we think it’s going to require a more flexible approach to asset allocation,” said Wylie Tollette, Franklin Templeton Investments’ head of client solutions.
January’s divestment started in the technology sector, where many companies could be negatively affected by rising interest rates. The Federal Reserve has sent hawkish signals in response to rising inflation. Last week, Jay Powell, chairman, indicated that a first-rate increase in March would be almost certain, and he refused to rule out that an aggressive sequence of increases should follow.
Higher rates reduce the value that investors attach to future earnings, and hit the prices of companies that advertise themselves to investors with promises of long-term growth. The technology-heavy Nasdaq Composite Index fell 9 percent, the worst one-month decline since November 2008.
As U.S. companies report their fourth-quarter results, earnings growth is also expected to slow after last year, when they were lifted by comparisons with a weak 2020.
While investors have offset rising interest rates and slowed growth for several months, the past few weeks have also added another complication: the threat of war in Ukraine.
Geopolitical risks are notoriously difficult to price into the stock markets, but several investors said rising tensions over a potential Russian invasion had helped spread weakness from technology stocks to the wider market in the second half of January.
“The situation in Ukraine is what made it go from something that was really focused on price-sensitive areas to more of a risk-taking,” said Tim Murray, capital market strategist at T Rowe Price.
Even without a war, a prolonged stand-off, including potential sanctions against Russia, could further push up global energy prices at a time when economies are already struggling to tame inflation.
Sebastian Raedler, head of European equities strategy at Bank of America, said that “the growth cycle in Europe looks particularly vulnerable because energy prices have risen so much, which is set to weigh on industrial activity”.
So far, however, European markets have performed marginally better than the US and have fallen 3.8 per cent. since the beginning of the year. The FTSE All-World Index fell 5.6 percent, its worst start in a year since 2016, when markets were hit by growth concerns in China.
Once stocks started falling, it was harder than usual for them to stop, according to Jack Caffey, a portfolio manager at JPMorgan Asset Management.
Years of constant stock price increases have deterred portfolio managers from holding even small amounts of cash so that they do not miss out on gains and risk criticism for underperforming benchmark indices.
“The markets in the United States have become one-sided – momentum is a strong thing,” Caffey said. “We have removed people’s ability to be contradictory… The less cash you have, the more your ability to take advantage of dislocations is challenged.”
Despite the challenges, the underlying US economy still appears to be in decent shape. Corporate earnings growth may be declining from last year’s peaks, but is still expected to remain positive for most large companies, and investors are looking for opportunities in the midst of volatility.
JPMorgan’s Caffey was among those who highlighted mature technology companies that they believe will be more resilient to inflation and may benefit from long-term trends such as rising demand for semiconductors, rather than temporary pandemic lifts for their business.
Others, including Murray at T Rowe Price, said they focused on smaller companies and “quality” stocks, which tend to have more stable earnings and stronger balances.
“When you get a really sharp market reaction, you have some babies being thrown out with the bathwater,” Murray said. “There are definitely some out there.”