The S&P 500 is now down over 10% year-to-date, with the NASDAQ and Russell 1000 Growth down over 15%. We wanted to update you on what we believe to be the primary drivers of the downturn and our thoughts, as the majority of the decline has come since our last communication on January 14.
What has changed since January 14?
- The main update has been corporate earnings, with more large firms echoing JPMorgan (who reported January 14) and citing rising expenses due to inflation, in particular wages. This has investors worried about corporate profit margins. The bulk of the S&P 500 will report earnings this week or next, so we will get even more updates on this front soon.
- Some near-term economic growth estimates, such as this morning’s flash US Composite Purchasing Managers’ Index (PMI) have come in weaker than expected due mainly to the Omicron wave and ongoing supply issues/labor shortages.1
- Expectations for the Federal Reserve to hike interest rates multiple times in 2022 have only strengthened, with Goldman Sachs now calling for more than four rate hikes this year.2
- The Russia/Ukraine stand-off situation has not improved.
The beginning of the year had been characterized by an aggressive rotation from high-price/earnings (P/E) multiple growth stocks into low-P/E value stocks, in particular into lower-quality cyclical stocks that rely on high economic growth/inflation. As this shift occurred, the overall index did not suffer much as investors were selling one group to buy the other. The primary cause of the rotation was high inflation and expectations for the Federal Reserve to raise interest rates, hurting valuation multiples of high P/E growth stocks in particular as more of their earnings are in the future and now need to be discounted back to the present at a higher rate. Financials fall primarily into the value/cyclical stock group and, starting with JPMorgan, the weak earnings guidance of banks due to higher expenses caused a change in investors’ outlooks. Now both groups are being sold, as investors worry about both lower P/E multiples AND a lower “E” (earnings) due to shrinking profit margins.
None of the news since January 14 is very surprising (higher wages, Omicron causing near-term issues, Fed hiking rates, Russia/Ukraine), as we wrote about all of these in our January 14 outlook. While the news was incrementally more negative on these fronts last week, we think the bigger change has been investor psychology, which was perhaps too optimistic coming into this year and has now shifted in the opposite direction. Our bottom line recommendation remains the same: We continue to recommend clients avoid trying to time the market and stay fully invested to their target risk level in good times and in bad. We continue to be confident that our holdings of high-quality stocks at attractive valuations will earn solid returns for long-term investors.