Fed moves in 2022 could end stock market pandemic

For two years, the stock market was largely able to ignore the reality that Americans lived during the pandemic – the increase in coronavirus cases, loss of lives and livelihoods, lockdowns – due to underlying policies that kept it dynamic.

Investors can now say goodbye to all of this.

By 2022, the Federal Reserve is expected to raise interest rates to fight inflation, and government programs to stimulate the economy during the pandemic will have ended. These policy changes will cause investors, businesses and consumers to behave differently, and their stocks will eventually take some air off the stock market, analysts say.

“This will be the first time in nearly two years that the Fed’s step-by-step decisions could force investors or consumers to become a little more suspicious,” said David Schawel, chief investment officer at Family Management Corporation, a management company. heritage in New York. .

By the end of the year, the general opinion on Wall Street is that 2022 will be a bumpier ride, if not quite a roller coaster. In a recent note, analysts at JP Morgan said they expected inflation – currently at 6.8% – to “normalize” in the coming months, and that it was unlikely the surge of the Omicron variant of the coronavirus is slowing economic growth.

LPL Financial, a brokerage firm, took a similar view, saying interest rates will rise “slightly” in 2022.

The S&P 500 stock index enjoyed excellent progress in 2021, rising more than 25%, on top of its 16% gain in the first year of the pandemic. The index hit 70 new closing highs in 2021, just after 1995, when there were 77, said Howard Silverblatt, analyst at S&P Dow Jones Indices. Shares on Friday edged down.

The market continued to rise amid political, social and economic tensions: On January 7, the day after a pro-Trump mob stormed the U.S. Capitol, the S&P set a new record. Millions of amateur investors, stuck at home during the pandemic, have also crammed into the stock market, buying up shares of all kinds of companies – even those no one expects to make money on, like the retailer of GameStop video games.

Wall Street also remained bullish on the business outlook in China despite Beijing’s growing tensions with the United States and the tightening grip on Chinese companies. Waves of coronavirus variants, from Delta to Omicron, and a global death toll of five million haven’t stopped the stock market from rising; his recovery after each panic attack was faster than the previous one.

“2021 has been a great year for the stock markets,” said Anu Gaggar, global investment strategist for Commonwealth Financial Network, in an emailed note. “Between federal stimulus measures to keep the economy going, the Fed’s accommodative monetary policy keeping markets liquidity and interest rates low, and continued medical improvement leading to surprising growth, markets have been in the best of all possible worlds. “

The past year also looked initially promising for new share offerings, and nearly 400 private companies raised $ 142.5 billion in 2021. But investors had sold many newly listed stocks on the New York Stock Exchange or Nasdaq by the end of the year. Renaissance IPO exchange-traded fund, which tracks initial public offerings, is down about 9% for the year.

Shares of Oatly, which makes an oat-based alternative to cow’s milk, climbed 30% when the company went public in May, but is now trading 60% below its closing price on the day. ‘opening. Stock exchange startup Robinhood and dating app Bumble, two other big public debuts, were down about 50% for 2021.

The first sign that the stock market could end its recent bull run came in the second half of 2021 when the prices of housewares, gasoline and more began to rise, triggered by disruptions in the supply chain. supply resulting from the pandemic. Used car prices have skyrocketed amid a global shortage of computer chips. As Covid-19 vaccination rates improved, companies trying to reopen have had to increase wages to attract and retain employees. Consumer prices rose 5.7% in November from the previous year, the fastest pace since 1982.

But even when “inflation” had become a buzzword worthy of a title in Onion, the stock market seemed slow to respond to price increases.

“The market is on the side that inflation is transient,” said Harry Mamaysky, a professor at Columbia Business School. “If it doesn’t and the Fed has to raise interest rates to bring inflation under control, then things could get worse in terms of markets and economic growth.”

And that’s what the Fed announced it would do in 2022.

When interest rates rise, borrowing becomes more expensive for consumers and businesses. This can hurt corporate profit margins and make stocks less attractive to investors, while undermining consumer demand, as people have less money to spend if their mortgage payments and other loans go up. Over time, this tends to deflate the stock market and reduce demand, which brings inflation back under control.

“I expect 2022 to be a bumpier race because returns won’t be as easy as 2021 or most of 2020,” said Greg McBride, analyst at Bankrate, a personal finance firm. “Even if the economy continues to grow, there will be concerns about valuations as the Fed tightens policy, which will lead to increased volatility.”

Higher interest rates could also dampen investor enthusiasm for stocks, as bonds would pay higher returns than they have in recent years. In fact, LPL Financial predicts that the yield on the 10-year Treasury bill, one of the most closely watched government bonds, will rise between 1.75% and 2% by the end of 2022.

Mr McBride said the values ​​of many stocks were supported by extremely low Treasury bond yields, particularly the 10-year yield, which held steady at around 1.5%.

“If that return goes up, investors will reassess how much they’re willing to pay per dollar of profit for the stocks,” he said. Even if corporate profits – which were strong in 2021 – continue to grow in 2022, he added, they are unlikely to increase “at a rate that continues to justify the current price of the shares.”

Nonetheless, what ultimately happens to the stock market in 2022 will depend on whether the Fed’s plans to reduce inflation by gently tightening monetary policy as planned.

In addition to an expected rate hike, the Fed is ending a pandemic program that was supposed to provide a safety net for the market. In the spring of 2020, the Fed began buying bonds to inject additional liquidity into the financial system and help companies stay afloat during sharp downturns in business. The Fed announced in December that it would step up the pace of withdrawal of this aid, which is expected to end in March.

“The nightmarish scenario is this: The Fed is tightening up and it isn’t helping,” said Aaron Brown, a former risk manager at AQR Capital Management who now manages his own money and teaches math at the Courant Institute of Mathematical. New York University Sciences. Mr Brown said if the Fed couldn’t orchestrate a “soft landing” for the economy, things could start to turn bad – quickly.

And then, he said, maybe the Fed will have to take “very aggressive measures like a 15% rate hike, or wage and price controls, as we tried in the 1970s. “.

In equal measure, the Fed’s moves, even if moderate, could also cause a sell-off of stocks, corporate bonds and other riskier assets, if investors panic when they realize that the free money that drove their risk taking to ever the greatest extremes over the past few years is definitely disappearing.

Sal Arnuk, partner and co-founder of Themis Trading, said he expected 2022 to start with something like “a hiccup”.

“China and Taiwan, Russia and Ukraine – if something happens there or if the Fed surprises everyone with the speed of the cut, there are going to be sales,” Arnuk said. “It might even start in Bitcoin, but then people are going to start selling their Apple, their Google.”

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