AE Wealth Management: Weekly Market Insights | 1/16-1/22/22

Market volatility continues as Fed tightening looms

Despite a holiday-shortened week, the market managed to do a significant amount of damage last week. The yield on the 10-year Treasury approached 1.9% before cooling off to 1.75%, but it’s still a lot closer to 2% than not. All this forced technology stocks into a tailspin, with the NASDAQ dropping into correction territory at the close on Wednesday. The selling continued the rest of the week; the S&P 500 dropped over 5% from recent highs while the NASDAQ remained in correction territory.

The 10% correction in the NASDAQ belies the reality that many tech stocks have been in correction territory for some time. The NASDAQ — and, frankly, the S&P 500 — would be in much worse shape if a narrow segment of the market representing a significant weighting in both indices had not outperformed and led us upward even as the rest of the market struggled. With the realization that easy money and the era of low rates may be coming to an end, the focus will shift to justifying the current valuation levels.

The Federal Reserve is meeting this week. Given the major-league whiff on the part of the Fed and the White House that pursued the “inflation is transitory” argument, the concern is that the Fed may not do enough to stop the rise in inflation — or possibly do too much and tank the markets and the economy. Unlike in the past, where we had low unemployment and nonexistent inflation levels, the Fed cannot step aside as inflationary pressures need to be addressed.

Fed Chair Jerome Powell will need to channel his inner Alan Greenspan and thread the needle by engineering a “soft landing” amid turbulent crosswinds. The economy slowed significantly in the second half of 2021, Omicron didn’t help that, and estimated gross domestic product (GDP) growth has been off. We may want this “Goldilocks” scenario to play out, with the Fed raising rates to tame inflation while keeping the stock market from selling off and the economy on track. But raising rates in a decelerating economy makes the opening in the needle much smaller and much more difficult than other challenges in recent years.

The last line of defense: Earnings aren’t stopping the bleeding in the markets

When the market started to get a little tipsy in the recent past, strong earnings acted like a responsible designated driver, ensuring everything ended well after a rough night. Earnings have been used to justify valuations that may have seemed lofty or historically rich by past standards. So far, this earnings season has been mixed, with firms reporting solid revenues, yet the future appears challenged. Sales were higher mostly due to higher prices thanks to inflationary pressures, which may not be sustainable going forward. Add in the fact that the U.S. consumer is beginning to show signs of exhaustion and slowing their spending, challenging the thesis that earnings will continue to be solid going forward.

This is the last line of defense for these valuations, and once the cost of doing business begins to go up in the form of higher rates, earnings may be challenged and may no longer come to the aid of increasing valuations. There is an awful lot of pressure on Fed Chair Powell, with his confirmation held up until February and President Joe Biden mentioning Powell by name in his recent news conference as the one person who can solve the inflation issue. Biden said, “Given the strength of our economy and pace of recent price increases, it’s appropriate — as Fed Chairman Powell has indicated — to recalibrate the support that is now necessary.”

As a result, markets predict a 93% chance of a rate increase in March. There’s a lot to line up for all this to go smoothly, and it will be tough for the Fed and the administration to accomplish that given their recent history. It seems as though they are both in a dark room looking for a light switch that hasn’t been installed yet.

Coming This Week

• This week will be a busy one as we head toward month-end. We’ll see the first reading of Q4 2021 GDP, which is expected to come in at 5.6% (up from the Q3 2021 reading of 2.3%). Expectations have disappointed with respect to GDP during all of 2021, and we don’t anticipate that trend to change.
• The Fed will meet for the first time in 2022 on Tuesday and Wednesday. It will be interesting to see the Fed’s actions, particularly now that the president has laid the solution to inflation at Chairman Powell’s feet. We’re looking for the Fed to announce plans to speed up the taper and four 25-basis-point (.25) increases in the next 12 months. Unfortunately, a 1% increase in short-term rates won’t fix a 7% inflation problem. The fear is that the Fed will miss the mark and not move aggressively enough.
• There will be other data points all week, including mortgage applications, new and existing home sales, retail inventories, personal spending, and consumer confidence and sentiment. All this data can act like kindling if the Fed fumbles or the GDP number is soft. Given the market’s mood, we could see renewed weakness this week.

Have a great week!

Tom Siomades, CFA®
Chief Investment Officer
AE Wealth Management

AE Wealth Management, LLC (“AEWM”) is an SEC Registered Investment Adviser (RIA) located in Topeka, Kansas. Registration does not denote any level of skill or qualification. The advisory firm providing you this report is an independent financial services firm and is not an affiliate company of AE Wealth Management, LLC. AEWM works with a variety of independent advisors. Some of the advisors are Investment Adviser Representatives (IAR) who provide investment advisory services through AEWM. Some of the advisors are Registered Investment Advisers providing investment advisory services that incorporate some of the products available through AEWM.

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