For the U.S. stock market, 2022 began with increased volatility. Since the beginning of the year, the S&P 500 index lost about 6% and the Nasdaq composite lost more than 11%. This time, however, the reason for the negative performance in the stock exchange is radically different from 2020. The COVID-19 pandemic caused a short-term recession in the U.S. economy (and a 26% drop in the S&P 500 in March 2020), which was followed by a fast and sharp (the “V-shaped”) recovery thanks to America’s unprecedented monetary and fiscal policy. And in November 2020, the success of pharmaceutical companies in developing vaccines gave even more confidence to the markets for further economic recovery.
As a result, the pandemic year of 2020 closed at +16% for the broad S&P 500. And 2021, which was accompanied by problems in supply chains around the world and rising consumer inflation, posted an even more remarkable nonreciprocal performance of +26.9% thanks to continued monetary stimulus, the lifting of some quarantine restrictions and the success of the vaccination program. Moreover, 2021 also already saw a rally in shares of cyclical industries related to the opening of the economy (banks, industry, oil and gas sector), in contrast to the solo boom of the technology sector in 2020.
At the same time, at the end of 2021, the world’s main central banks, primarily the U.S. Federal Reserve, changed their rhetoric and set a course for tightening monetary policy in the form of higher interest rates and curtailing quantitative easing programs. Now, the key issue on the agenda is the fight against price increases, which have reached over 7% per annum in the U.S. Talk of inflation is already moving into the realm of political issues, with American consumers unhappy over such high prices; this is causing a steady decline in President Joe Biden’s ratings. However, the timing of a rate hike could be superimposed on a slowing economy, as evidenced by the International Monetary Fund, Fed forecasts, declining business and consumer activity indicators, all of which would further complicate the problem of corporate and private debt servicing, putting into question the prospects for further growth, or even cause another wave of defaults.
The winding down of the quantitative easing program, which, although it has a questionable impact on the real economy, has a positive effect on stock market growth and does not inspire optimism either. Thus, investors’ concerns about the future actions of central banks translate into nervousness and increased volatility in the stock market. Shares of technology companies from the Nasdaq are particularly effected, as they are considered to have benefited from the pandemic he beneficiaries of the pandemic situation given that the entire world has gone online for work, shopping, education and communication.
Shares of these companies were grossly overvalued. When interest rates rise, the most expensive securities tend to be the ones that are negatively overvalued. In addition, technology companies are beginning to lose business momentum gained during the pandemic. Negative forecasts and revisions of financial plans presented in the fourth quarter 2021 reporting season contributed to a sharp drop of more than 20% in shares of even such large and financially stable companies as Netflix, PayPal and Facebook.
In the current market, it makes sense for a private investor to pay attention primarily to the structure of their portfolio. The proportion of investments in short-term bonds of reliable issuers can be increased, and an increased cash reserve should also be available to mitigate the negative impact of market volatility and subsequently be available for purchasing cheaper stocks. As with any stock market turbulence, the current correction may be perceived as an opportunity as well as a threat.
In spite of the political backdrop with inflation, tightening of monetary policy by the Fed may be limited, because strong panic and deep corrections in the stock market could adversely affect U.S. consumer sentiment. This, in turn, could exacerbate the state of the U.S. economy. Thus, shares of big tech companies, which suffered most heavily as a result of changes in the central banks’ policies, might be of special interest to investors in the long term. In addition, the ongoing trend of digitalizing the economy and the low level of debt in the technology sector will contribute to this interest.