After a torrid session on Wall Street on Monday, stocks are expected to rise today, as they have in Europe.
That doesn’t take anything away from the fact that, so far, 2022 has been a rotten year for stock investors.
YTD in 2022, the FTSE-100 is down 1.69%, while Germany’s DAX is down 14.5% and France’s CAC-40 a similar amount. The MIB in Italy is down by almost 15.5% and the AEX in the Netherlands by almost 16%.
In Asia, Hong Kong’s Hang Seng is down 16% year-to-date, while China’s Shanghai Composite is down 16.5% and Tokyo’s Nikkei 225 is down 10.5%.
In the US, it has been even more dire, with the S&P 500 down 16.25%, the Dow Jones Industrial Average down 11.25%, the Russell 2000 – the leading index for smaller US companies – down 11.25%. – 21.5% and the Nasdaq an overwhelming 25.75%.
There are several factors behind this drop, including the uncertainty created by Russia’s attack on Ukraine, although that does not explain why the main US indices have fallen more than their European and Asian counterparts.
Another is the growing supply chain bottlenecks created by the resurgence of COVID-19 in China and the hardline restrictions Beijing has imposed in response.
That relative weakness is explained by the biggest and most important factor behind these global setbacks: the growing threat of inflation and the actions being taken around the world by central banks like the US Federal Reserve and the Bank of America. England in response.
The Fed last week raised its main policy rate by half a percentage point, its biggest increase in two decades, while the The bank raised its main policy rate for the fourth time in as many meetings.
But this is not something that only happens in the US and UK.
Around the world, central banks are tightening monetary policy, including the central banks of South Korea, Canada, Sweden, Poland, Israel, Chile, South Africa, and Mexico. Perhaps the most notable of recent times was the Reserve Bank of Australia which, last week, raised interest rates for the first time since November 2010.
It has raised concerns in the minds of investors as to the extent to which global growth will be affected by these rate hikes and, by extension, corporate earnings that drive share prices and allow companies to pay dividends. to shareholders.
Some investors worry that central banks like the Fed and the Bank are ‘behind the curve’, in the jargon, when it comes to inflation, raising the risk that interest rates will have to rise further. than they would have if these institutions had acted. more quickly.
The Fed is also about to embark on so-called ‘quantitative tightening’, reversing some of the extraordinary asset purchases it made during the pandemic to keep liquidity flowing through financial markets, which has the same impact as raise the cist of loans.
The Bank was also expected to announce something similar last week but for now this seems to have been parked in the ‘too difficult’ box.
The general threat of higher inflation and central banks reversing some of their asset purchases has pushed up yields (which rise as prices fall) on government bonds. The yield on US 10-year Treasury bonds reached its highest level since November 2018 on Monday this week and, since the beginning of the year, has risen from 1.51% to 3.20% in a given time on Monday.
That’s a huge increase in such a short space of time. For UK 10-year gilts, the rise has been just as dramatic, with yields rising from 0.972% at the start of the year to 2.073% on Monday, a level not seen in November 2015.
Even in the eurozone, where there is much less chance of the European Central Bank unwinding its pandemic-era purchases, yields have been rising.
The German 10-year bond yield is currently at its highest level in eight years. More worrying, bringing back memories of the sovereign debt crisis in the eurozone, is the widening of the ‘spread’ between the yields of the different government bonds of the bloc. For example, the yield on Italian 10-year bonds is currently 3.077%, compared to just 1.06% on German 10-year debt.
These increases in bond yields have an impact on the equity market, especially in the technology sector, where the sell-off has been most brutal.
An estimated $1 trillion was removed from the collective value of major US tech stocks over the past three trading days, with Tesla falling in value by $199 billion, Microsoft by $189 billion, Amazon by $199 billion. 173 billion and Alphabet, the parent of Google, for $123 billion.
Tech stocks are more vulnerable to expected increases in interest rates. This is because the stock price of any company simply reflects what investors are willing to pay for future cash flows from that company in the future and, as technology companies are supposed to have better long-term growth prospects , those expected future cash flows have tended to earn them a higher rating in the stock market.
However, when bond yields rise, the present values of those future cash flows tend to fall, because it becomes harder for investors to justify holding high-value tech stocks when they could hold less risky assets, such as bonds. of the government, paying them. more today.
This is something that investors have begun to take into account since, in January, the Nasdaq entered ‘correction territory’.
The more overvalued a stock was previously, the more it has to fall now, while the sell-off has been particularly hard on those tech companies hit by particular problems.
Netflix, for example, has seen its shares drop 64% over the past year after reporting its first quarterly drop in subscriber numbers in more than a decade.
Meanwhile, Amazon is down 30% in the past 12 months after spooking investors with its first quarterly loss since 2015 amid growing concerns about the extent to which online shopping is slowing. Peloton, another longtime tech darling, today became the latest to disappoint investors with its latest sales figures.
Tech stocks aren’t the only risky assets that have suffered a big sell-off. Crypto assets, which tend to trade much like tech stocks, have also taken a beating. Bitcoin has fallen 35% since the beginning of the year and has reached a price last seen in July of last year.
The question is how far stocks fall from here, and many investors remain deeply bearish.
Max Kettner, chief multi-asset strategist at HSBC, told clients on Tuesday: “The performance across asset classes in recent weeks can be described in one word: brutal.
“Our view remains firmly risk aversion. Virtually all of our fundamental and cyclical indicators clearly point to a growth scare looming, not in 2023, but in the next three to six months. As such, despite our sentiment to short-term and positioning indicators and being bearish, we remain firmly out of risk.”
And Bill Blain, a strategist at investment management firm Shard Capital, said: “I remain convinced that global stocks and equities are grossly overvalued relative to the outlook for the global economy.
“That’s not just due to the deepening of the new COVID lockdown crisis in China (which threatens a catastrophic repeat of the supply chain failures of 2020-21), energy and food inflation, the war of Ukraine, but also by unraveling the consequences of 12 years of market-distorting currency experimentation and cheap liquidity.”
These views are by no means atypical. Global growth is slowing, and with it, corporate profits will shrink for those companies forced to absorb the impact of higher inflation. Meanwhile, for those companies that benefit from higher inflation, such as oil and energy companies, the threat of windfall taxes may be growing.
There may be rallies as seen today, as bargain hunters step in.
But it doesn’t feel, at this point, as if the sell-off that has characterized markets of late is over.