A Year of Reversals
2021 was “a year of recovery,” with very little downside in the stock markets. 2022 was “a year of reversals.”
The sharp recovery in the global manufacturing and services Purchasing Manager’s Index (PMI) in 2021 is reversing. Hayes does not expect a slowdown similar to that in 2020, but foresees moderating economic growth against inflationary pressures.
Another reversal is in central bank policies. The Federal Reserve (the “Fed”) is likely to raise rates starting March. With slower global growth, a reversal in corporate earnings growth is also expected. All these reversals indicate uncertainty and a sharp return of volatility.
Factors that contribute to this uncertainty include monetary policy, supply chain issues, and the Ukraine-Russia situation. Central banks in emerging and developed countries alike are moving into a tightening phase, as the Fed intends to reduce its balance and raise rates in 2022. But Hayes does not believe that this will change the longer term trend. That would require a significant deterioration in the macro-economic environment.
Rate Hikes
Hayes highlighted that markets usually withstand the early stages of a rate hike as markets recognize a favorable earnings environment. But after a series of rate hikes—historically, three rate hikes—yields start to flatten sharply, turning into a more negative situation.
Four rate hikes are expected this year, reflecting higher inflation and defensive market expectation. This could trigger another round of selling. But will the rise in interest rates replicate the events in the 1970s? Tim thinks that this requires a much higher inflationary environment than that experienced so far.
A Secular Bull Market
With the market rising 15% annually since 2009, NDR considers that a secular bull market has been in effect since 2009 and shall persist, consistent with past secular bull markets. While a cyclical bear market is inevitable, Tim was uncertain whether it will take place this year or next year.
Earnings yields and market valuations have improved, and stocks are not overvalued relative to bonds. The wide spread between earnings yields and wide bond yields have persisted for the past 20 years.
With real interest rates dropping below zero to nearly -6% and likely to remain negative, gold should benefit.
Amid such uncertainty and consequent volatility, markets undergo extreme rotations as money moves away from sectors such as technology towards sectors that benefit from high interest rates such as financials. Tech is overvalued in the US, weighing down the entire market. Energy and materials have held up and around 10 emerging markets have performed well.
Cryptocurrency
The performance of cryptocurrency assets cannot be predicted or studied accurately. NDR models based on historical relationships between data series and markets do not apply to Bitcoin, given its lack of history and inconsistent correlation. It is hard to observe long-term secular or cyclical trends. The volatility of Bitcoin exceeds any other asset class and investors in cryptocurrency must be ready for such volatility. Bitcoin is not a viable option for a portfolio that aims to preserve capital given its volatility and increased regulations.
Conclusion
Naji concluded that amid the long-term secular bull market, our clients’ long-term investment strategy should be resilient to the cyclical bear sell-offs, allowing them to over-ride these downward trends and minimize volatility.
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