February Economic Update
Rising bond yields, elevated inflation, policy shifts from the Federal Reserve, and tensions on the Ukraine border unnerved the stock market in January to begin the year. The Dow Jones Industrial Average slipped 3.32%, while the S&P 500 fell 5.26% and the tech-heavy Nasdaq was impacted the most, pulling back 8.98%. (1)
The Federal Reserve & Interest Rates
Anxiety about the Federal Reserve’s pivot from its accommodative monetary policy toward monetary normalization hung over the market all month. The first update that rattled the markets was the likelihood of an interest rate increase in March, which would be sooner than many had expected. The second update that upset investors was news that the Fed was considering not only tapering its bond purchases, but also selling bonds it currently holds into the market, which was a step that had not been widely anticipated any time soon.
As investors saw in January, these high-multiple stocks can come under pressure as bond yields trend higher. The reason for this is twofold. First, when interest rates tick higher, it’s more difficult to forecast future earnings. Second, higher interest rates may increase a company’s borrowing expenses.
Interest Rates & Tapering Bond Purchases
Gross Domestic Product, which is the rate of economic expansion, exceeded economists’ expectations in the fourth quarter, rising 6.9% which was triple the growth rate of the previous quarter. While the headline number was strong, two concerns emerged: Much of the growth was due to inventory build-up, and the price index for personal consumption expenditures (an inflation measure) accelerated from the third quarter, climbing 6.5%. (2)
Durable goods orders, which are often a sign of economic expansion or contraction, declined 0.9%, which likely reflects the impact of the Omicron surge. Retail sales declined by 1.9%, which was also likely due the spread of Omicron, in addition to early consumer holiday buying in response to possible inventory shortages which dampened spending in December. (3)
After the strong market rebound off of the COVID lows in 2020, followed by an impressive grind higher in 2021, it has been some time since investors experienced what can at this point be called a routine market pullback, which are commonplace under more traditional economic conditions.
There are also many similarities to the beginning of last year, particularly with the Nasdaq and technology sector. In February and March of 2021, the Nasdaq experienced a 10% pullback, which was largely attributed to rising interest rates - similar to the current pressures we are experiencing. The Nasdaq went on to finish the year by gaining 32% from those March lows. While we cannot assume we will have a similar move this year, it is important to properly frame this market pullback within a recent historical context.
February will likely be a month of whipsaw moves - both higher and lower - as the Federal Reserve’s policy is rapidly shifting. Concerns will also continue regarding the Russian build-up of military forces on the Ukraine border; a situation which we hope is a “bluff” move from the Kremlin and will not result in any wartime conflict. Barring any major changes with the forementioned, further pullbacks will likely be interpreted as buying opportunities for high-quality companies with strong balance sheets and long-term growth projections.
Monthly Financial Tip:
Establish a timeline for your financial goals. List what you want to achieve and when, then review your progress and the deadlines you have set semi-annually or annually.
1 WSJ.com, January 31, 2022
2. WSJ.com, January 27, 2022
3. CNBC.com, January 27, 2022
This post has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. Bob Lawson is not engaged in rendering legal or accounting services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.