We’ve Seen This Before…

Stock and bond markets are certainly not behaving well in the early days of 2022. The bond market action is understandable and was predicted by us and many others. The Federal Reserve Bank in the form of its head Jay Powell has told investors that interest rates are going up and with that, bond prices are going down. More recently, Chairman Powell has been more definitive in his advice about interest rates – alluding to a scenario where interest rates will be going up more than earlier expected and more quickly than earlier expected. As the facts have changed, so also has the Fed’s outlook. Getting inflation under control seems to be “charge #1” at the moment, because full employment (the Fed’s other main charge) seems to be well in hand. The stock market’s “knee jerk” negative reaction to this recent turn of events, however, seems a bit much after considering that even after the recent rise in rates, interest rates are still at extremely low levels historically.

What sort of evidence from the past could give investors some predictive value as to the near-term direction of equity prices? Well, investor sentiment as measured by the American Association of Individual Investors is very low. Only 21% of respondents to a recent survey expect stocks to gain in value over the next 6 months. This is lower than 97% of all readings since 1987. Such a low reading usually portends stock market strength – as the sellers have already done their selling and are out of the markets. So the selling dries up and all that is left is buying. Further, the economy is strong as measured by the Q4 GDP growth rate of 6.9% year over year. With no recession in sight companies should do well and this should be reflected in equity prices.

Corporate earnings season has started. It is early days – but so far, results are exceeding Wall Street expectations, which will support stock prices as they have for years. Further, company management teams are still sounding rather upbeat about the condition of their customers. So, ahead of expectation earnings results combined with a positive outlook for upcoming quarters should translate into better stock prices.

We have commented in the past that rising interest rates, especially at the start of a season of interest rate increases, have not historically been bad for stock prices. The economy can take higher interest costs without falling into a recession. Investors think that rising rates up to a certain level (it is thought that a 10-year Treasury rate of around 3.60% could pressure equity prices, currently it’s yielding just 1.80%) are not competition for equity investments – but a sign of a healthy economy with strong company earnings. This is where we are now.

Sell-offs always feel uncomfortable, especially when one is in the middle of one. Markets usually experience two drawdowns of more than 5% in any calendar year. So far, the S&P 500 is down 8.3% in 2022. Real (inflation adjusted) interest rates are up and stocks are down pretty sharply over a short period of time. The market reactions are not unexpected – but the severity of them is a bit stretched, we think.


President Putin, we are told, plays 3-dimensional chess. A former KGB operative, he is always thinking several moves ahead of his opponent. He is unscrupulous. He is corrupt. He can be a bit emotional, but this is usually kept well in check. He feels “disrespected” by the West. His power, right now, is absolute – so some Putin watchers wonder if he listens to anyone besides himself. With tens of thousands of troops on the Ukrainian border and a NATO which seems more united than many times in the past, has the Russian President “painted himself into a corner” with precious few diplomatic off-ramps to step back and save face? A full-on assault of Ukraine, we still think, would be too costly for Russia in terms of rubles and body bags. President Putin is not as popular as he once was after years of economic hardship due to sanctions imposed by the West after Russia took control of Crimea, Donbas and Luhansk. Heightened internal discontent layered on top of external problems might be the “straw that breaks the camel’s back”. Perhaps a solidification of the Russian position in Eastern Ukraine and then a decompression of the situation with a drawdown of Russian troops on the Ukrainian border would calm various parties. This de-escalation of risk might well provide a nice boost to the markets around the world. Just a thought…….