- Investors worry about rising bond yields and the effect on the economy and equities.
- The technology sector has borne the brunt of the sell-off and approaches a correction.
- The Fed may need to raise rates more aggressively than the markets currently anticipate.
U.S. equities continued their path of least resistance and headed down for another day. Though concerns about corporate earnings weighed on investors, the primary culprit remains rising bond yields and the potential impact on economic growth and equity prices. As we wrote in our 2022 Market Outlook, we continue to believe the Fed’s hawkish pivot will weigh on investors and contribute to an uptick in overall volatility.
As has been the case all year, equity markets took their signal from the bond market, as higher Treasury yields and the Federal Reserve's less accommodative plan appear to be weighing on investor sentiment. With 10-year Treasury yields trading around 1.87%, this level marks the highest point for the 10-year Treasury yield since early 2020. With the move higher in bond yields, expensive high-multiple growth stocks have come under pressure. Generally, technology and other high-multiple stocks are impacted by interest rates because they tend to have higher stock price valuations that are calculated based on projected future earnings. Higher yields create higher discount rates for valuing those future earnings streams and thus the stocks become less valuable. Technology stock valuations have been lofty in this low yield environment, hitting levels not seen since the dot-com bubble. As has been the case all year, of all the major market indices, the technology-heavy Nasdaq Composite was the worst performing index, falling 2.6% on Tuesday and is now nearly 10% below its November 19 closing high. Keep in mind that a decline of 10% is generally considered a correction.
With the Fed now firmly entrenched in a more hawkish camp, questions linger regarding how fast they could raise the Fed Funds Rate in 2022. A possible answer is to look at the 2-year Treasury yield, which tends to represent a proxy of what this rate will be one year from now. With the 2-year Treasury yield trading at 1.04%, the first time it has pushed above 1% since 2020, this suggests that investors are now expecting potentially four rate hikes this year. With wage growth, owners’ equivalent rent, and other so-called sticky inflation metrics lingering longer than the Fed suggested during 2021, some Fed officials have discussed the possibility of raising rates even more frequently in 2022. With yields rising, the impact on the economy could be of concern. According to Credit Suisse, each 1% rise in bond yields reduces GDP growth by 1.0% to1.5%. The 10-year Treasury yield is now about 0.35% higher in 2022.
Though investors primarily took their cue from rising yields today, a poor start to the earnings season also weighed on investors. Over the last couple trading sessions, a few high-profile banks missed earnings estimates on wage pressures and other cost-related disruptions. Given the importance of the financials sector in our economy, weak earnings performance further added to negative sentiment.
In 2022, our primary investment themes are slowing economic growth, a more hawkish Fed, and an increase in market volatility. With market risks rising, we continue to anticipate more volatility in the near term. Any disruption to current expectations could be a headwind for stocks, and with stock market valuations priced to perfection, this could amplify any volatility. We may see a stock market correction at some point this year, but we still don’t expect a big sell-off as we saw in early 2020. Still lingering stimulus, a financially healthy consumer, and the eventual abatement of supply chain issues suggest limited market downside.
We maintain that diversification is the key in this market. In these times, we can help you stay focused on your long-term risk and return goals and help you with your personalized investment objectives.
This report is created by Cetera Investment Management LLC.
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