2022 I Thoughts on January 2022 Market Declines

2022 I Thoughts on January 2022 Market Declines

Last week we sent the below letter to our clients addressing the market’s volatile swings so far in 2022.

These brief letters, which we refer to as Flash Alerts & Guidance, are a cornerstone of our client communication plan. Whether it’s the Covid crash, a tax-law change, or our general thoughts on the markets, we aim to update our clients on how we’re evaluating and managing the current environment.

The underlying message is usually the same:

  • If your goals haven’t changed, your portfolio shouldn’t either.
  • The financial plan that was right for you yesterday is still appropriate today and will be tomorrow as well.
  • We want to act continuously on a plan rather than reacting to the markets.

With that being said, here’s our most recent Flash Alert:

What Happened

Today, the S&P 500 rebounded to post a +2.4% return after a very volatile week.  Year-to-date, the S&P 500 is down -7.4% and briefly entered correction territory (-10% or more) on Monday before staging a comeback. The major concern continues to be Fed tightening, with the market now pricing in a cumulative +1% rate hike by the end of 2022.

Most of the correction is concentrated in riskier assets and more specifically, stocks in the technology and consumer discretionary sectors that did very well last year. The prospect of higher interest rates is having a big effect on these companies because many believe higher interest rates driven by inflation discount the value of these companies. Whether this is true or not is up to debate.

Reaction & Opinion

With an annual inflation rate of 7% at the end of December, the Federal Reserve is speeding up its tightening and has planned 3-4 interest rate hikes this year. Higher inflation has been primarily caused by supply chain problems and higher than average consumer demand. Omicron has only exacerbated the problem as many companies are having trouble finding people to work.

Overall, we believe the Fed’s move to increase interest rates is good for the economy as it will tame interest rates and set us up for continued economic expansion. That said, many clients have been asking us at what level are interest rates detrimental to the economy?

As you can see in the chart below, when the 10-year Treasury surpasses 4%, stocks generally start to move in the opposite direction.1 This is because many investors will now be able to buy a corporate bond earning 5-7%, which is perceived to have lower risk and a competitive return to stocks.

Currently, the 10-year Treasury is yielding close to 1.8%. If you add in the scheduled rate hikes for this year, the ten-year will likely still be below 3%, which means we have ample room before bonds start “competing” with the stock market for investments. Interest rates may be a concern for some, but our research suggests the current correction will likely be temporary.


What HCO is Doing

Given our opinion, we view this correction as an opportunity to:

  • Rebalance accounts – selling bonds and buying stocks
  • Harvest tax losses by selling stocks with a temporary drop and buying similar investments to maintain equity exposure; and
  • Invest additional funds.

One of the fundamental principles of success in the stock market is “never convert temporary declines into permanent losses.” This is such a situation.

We will monitor events closely and revisit our current portfolio positioning if we think additional action is warranted. As always, we’re happy to discuss your situation and invite you to e-mail and call us.

Sincerely,

Ian A. Hamre, CFA

Managing Partner

HCO Private Wealth

1 JP Morgan ‘Guide to the Markets’ slide 17 Interest Rates & Equities. Data as of 12/21/21

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