Buckle up! There could be more market volatility ahead

Stock market moves are often spoken of in the context of a rollercoaster ride.

If the analogy was real, investors would have had white knuckles by the end of January.

As they entered the new year, they approached the summit of the ride with global markets sitting at close to all-time highs; the US markets actually hit a record in the opening days of 2022.

And it had been a pretty spectacular climb from March of 2020 when a sell off knocked about a third off the value of indexes globally.

Barring a few dips here and there, the movement has been pretty much in one general direction.

But like all the best rollercoasters, there was an adrenalin-surging twist waiting around the corner.

Inflation January

In the space of days, stocks went from all-time highs to plumping quite perilously.

« Under normal circumstances, we could put the skittish investor sentiment down to the lingering effects of a post-festive season full of excessive merriment, » Aidan Donnelly, Head of Equities with Davy explained.

But there was something different about this time.

It started off as a sell-off in very high growth, non-profitable companies, but that spread to wider segments of the market, giving the Nasdaq (technology heavy index) its worst start to the year since the financial crash over a decade ago , Mr Donnelly pointed out.

« If Anchorman Ron Burgundy was reporting on the market action since the beginning of the year, he would surely sum it up with his phrase « Well, that escalated quickly! ».

So, what caused such an abrupt about turn?

In short, the topic that’s likely going to dominate economic and market commentary for much of this year – inflation, or to put it more plainly, the rising cost of living.

The guiding principle for central banks is that they like to keep inflation at or, preferably, just below 2%.

It’s currently running at a rate of over 5% in most major growth.

The main lever for controlling that is interest rates. If prices are rising at a pace that’s considered too hot, rates can be hiked to try to take a bit of heat out of the economy.

And that’s an issue that Central Banks – and indeed stock markets – haven’t had to contend with for many years.

In fact, with rates at close to zero and billions of being pumped into the system in the form of bond purchases, there was a plentiful supply of cheap money sloshing around the system.

And stocks were among the biggest beneficiaries of that largesse.

« The Fed (the equivalent of the US Central Bank) is faced with historically tight labor markets and too high inflation, and while his predecessors had the luxury of factoring in the impact of stock market volatility on the financial conditions of consumers, Jerome Powell ( Fed chair) is more than aware that the market tail can’t wag the monetary policy dog ​​this time, » Aidan Donnelly explained.

To put it another way, the market is not going to be factored into the Fed’s decision making and investors can have as many tantrums as they like.

Tech stock carnage

Stocks in the technology sector, those that performed incredibly strongly throughout the pandemic, have borne the brunt of the selling.

They had wavered before as reopened from different phases of lockdown and the ‘stay at home’ factor driving their gains was seen to have waned, but the stock prices managed to continue to rebound.

The wider tech sector is viewed as being particularly sensitive to interest rate rises, partly because they tend to have high debts – which will be impacted by higher potential interest rates – but also by the impact on the growth that’s expected from these companies – and is very often baked into their share prices.

« We were expecting volatility to pick up and it has not disappointed, » Paul Sommerville of Sommerville Advisory Markets said.

« In simple terms we can see the interest rate sensitive and very highly valued frothy end of the market is suffering, » he explained.

He summed up the extent of the hit to markets in January.

By the end of the month, the S&P 500 – a broad index of the top 500 stocks in the US – had suffered a bigger drawdown in 2022 than it had in all of 2021.

It slipped briefly into correction territory at one point – defined as a fall of more than 10% from its all-time high – along with the Nasdaq (which is mainly made up of tech stocks).

The Russell 2000 index of small cap stocks fared even worse with a 17% decline.

« The Nasdaq gave up 6 months gains in 3 weeks, » he explained.

« The FAANGS are coming off the boil. »

These are the group of the biggest tech stocks – Facebook (Meta), Apple, Amazon, Netflix, Google (Alphabet).

If January was bad, worse was to come as February rolled around.

Meta Disaster

Much like January, February started off with what appears to have been something of a false dawn.

Stocks settled somewhat as quarterly results provided some direction and calm.

Some of the tech names managed to pull back some of the losses that had been wracked up in the previous weeks.

Then Facebook – or Meta, as it’s now known – published its latest quarterly results in the middle of this week.

To say that they disappointed would be an understatement.

The selloff resumed, initially with Meta and then it spread throughout the wider market.

« Meta shares plummeted 26%, equivalent to more than $200 billion of its market capitalisation. In terms of value, that was the largest ever single day fall by a US company, » Richard Hunter, Head of Markets at interactive investor explained, by way of context.

« It is becoming evident that not only does sentiment remain fragile, but earnings misses are being severely punished, » he added.

Paul Sommerville said the move was more deep-seated than just one set of results.

« There was no bounce at all, and the stock closed on the low of the day. This point is important as it points not to a ‘blip’ in the earnings but a fundamental re-rating of the stock price, » he explained.

However, he cautioned against further panic reactions.

« The atmosphere in the markets is frantic and feverish so it is important to look at it calmly and rationally, » he advised.

Amazon to the rescue?

Online retailer Amazon provided some calm to the situation when it reported numbers on Thursday night.

Shares soared 17% after the bell with Snap and Pinterest providing some reassuring stability too.

However, Paul Sommerville said this too had to be put in context.

« Amazon stock was down 16% over a year, before the results. It was down 18.5% in 2022 before Friday. Even after the results Amazon is still down for 2022. »

He said how it performs in the near term would be an important indicator for the overall market.

« Any failure of the rally by the end of the day (Friday) would be another blow to the confidence of the ‘buy the dip’ mentality that is so ubiquitous.

« Where they close could have a major bearing on the price action for the coming weeks. Keep an eye on Amazon, » he advised.

By close of business on Friday, Amazon stock was around 13% higher at over $3,155 a share.

The overall Nasdaq closed just over 1.5% higher signaling some stability for now.

Does this matter to anyone other than rollercoasting investors?

Many people took up the practice of ‘day trading’ in the last two years, particularly in the early days of the pandemic, with millions buying shares on a host of new trading apps.

There was one infamous trader who recorded his trading exploits online, randomly choosing stocks corresponding to letters he pulled out of a bag, so confident was he that stocks only went up.

That narrative has changed somewhat in recent weeks with many carrying tech heavy positions now potentially nursing significant losses.

In addition, anyone who contributes to a DC (defined contribution) pension scheme (which is most working people who have pensions now) likely has quite a big exposure to stock markets.

Given that these investments are made for the long term, it’s generally advised to sit still and ride out periods of volatility and heavy selling.

For those coming closer to retirement, they should have started to reduce their exposure to more volatile parts of the market already.

Where to now?

The path ahead will likely be dictated by a combination of company performance and Central Bank moves.

With the Bank of England already having hiked interest rates twice in the past two months, the US Federal Reserve is set to follow course with possibly as many as five interest rate hikes this year.

The European Central Bank – having previously all but ruled out any rate rises this year – now appears to be shifting its stance with President Christine Lagarde declining on Thursday to give any guarantee that rates would not rise in 2022.

The inflation situation is fast moving, effectively forcing the hand of Central Bankers.

And market traders are at their mercy.

There are a few more twists to come on this rollercoaster. Buckle up!