It’s never just one thing. Anytime the market drops by 10%, known as a correction, there are multiple factors. Even in March of 2020, when the market dropped precipitously, the virus and global shutdowns were the leading causes, but other factors played a role as well.
During the day on Monday, we reached correction levels in the US markets, meaning the S&P 500 dropped 10% from the all-time highs reached just a few weeks ago. So, what are the drivers of this recent drop? And, more importantly, are these factors likely to be a short blip or a longer-term issue?
Interest Rates – The US Federal Reserve is likely to raise interest rates this year from 0.00%, where rates have been parked for nearly two years. The current expectation is that the Fed will raise rates 3-4 times this year (at 0.25% per move) beginning in March. The market has already moved treasury bond yields some in anticipation. Even if the Fed does raise rates four times this year, increasing the overnight lending rate to 1.00%, rates will still be at historically low levels. In fact, from 1963 until 2003, the rate never went below 1.00%.
Companies that have a high debt load may see an almost immediate impact on margins from higher rates, but for many stocks, that’s not why higher interest rates have negatively impacted their share prices. Valuation formulas for high growth stocks, especially those lovingly referred to as “pre-revenue”, involve an interest rate component. The higher rates go, the lower prices on these shares should drop according to these formulas, as we have seen take place since mid-November.
Inflation – There’s no doubt that inflation is hot. 2021 saw inflation rates (as measured by the Consumer Price Index or CPI) not seen in 40 years. I’ve written about inflation in the past (most recently in November) and my opinion hasn’t changed.
As an aside, I feel like the fact that CPI numbers are on a year-over-year basis always gets overlooked. Yes, the number was 7% in 2021, but on a 2-year basis inflation averaged 3.96% per year (3.31% for Core CPI, which excludes food and energy prices) due to anemic inflation in pandemic ravaged 2020. Higher than we’ve seen recently? Absolutely. Outlandish? Not even close.
COVID (still) – The Omicron wave is working it’s way through the country, leading to fears of more shutdowns and a slower economy. Particular to where many market prognosticators live and work, this variant burned hot in New York City beginning just before Christmas. As has tended to be the case in other areas, Omicron builds fast and dies out just as quickly. Experts I believe in think this variant wave will be mostly done by the end of February, if not before.
Global Concerns – Will Russia invade the Ukraine? Is China slowing down manufacturing because their economy is slowing, or because they want clean air for the Olympics? Will China, and it’s territories, ever move past a zero tolerance policy when it comes to COVID? Should El Salvador really be putting more of their country’s treasury capital into Bitcoin?
There are always global concerns baked in the market forecasting pie, but the Russia/Ukraine and Chinese slowdown stories seem to have captured a great deal of attention. If that attention is warranted or not will be determined down the road.
Based on where we stand today, I don’t see any of the factors above causing a long-term drop in the stock market. While the likelihood of a rip-roaring market like we’ve seen since March of 2020 is low, I also don’t anticipate negative performance in 2022. That would make this most recent dip an outstanding opportunity to buy quality, long-term equity investments.
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