Weekly Update

A Bit of Calm Returns to Stocks

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Published March 25, 2022


The stock market has settled down quite a lot in recent days as this chart of the volatility index shows. When volatility jumped down over that blue trendline, and kept going down, it was a likely sign that stock investors could breathe a little easier. Nevertheless, we also note that volatility has been generally elevated since mid-November and has a ways to go before true calm returns to the market.

Stock market settled down in recent days

With a good overview of recent moves in interest rates and the market, we reprint a recent analysis from our friends at Delta.

“It is often easier to see financial speculation when assets are being sold rather than bought. The 80% 2000-2002 tech bubble collapse and 2008-2009 housing market demise are examples of speculation becoming painfully evident as assets were sold.

Speculation in financial assets is enabled with easy money. Easy money means very low interest rates and/or increases in money supply. Putting readily available money to work in speculative assets increases as interest rates (the cost of capital) approach zero. Since 1992, annual money supply growth has averaged 5.5%. Over the past 24 months (during the Pandemic), money supply peaked at 27% and averaged 18%.

Fed funds rate and money supply growth

JPMorgan Asset Management market strategist Dr. Kelly likes to say, “When the carrying costs of crazy are no longer zero, valuations are likely to go down.” At the start of 2022, most Wall Street analysts believed the Federal Reserve would raise the Fed Funds rate two or three times this year. As inflation reports soared, Fed rate hike expectations quickly rose to five and even to seven 25 basis points moves. In the past week, the Fed has been signaling seven rate hikes this year.

The Federal Reserve raised the Fed Funds rate on March 15, the first rate hike in more than three years. As of March 15, the major U.S. stock market indexes were negative on a 12-month basis. What is somewhat shocking is how far down the average stock traded. For example, the drawdown in the average NASDAQ stock was -46.6% over the previous twelve months versus a -22.2% pullback in the market-cap weighted index.

12-month drawdown of U.S. indices

The chart above highlights that the stocks of large, profitable companies significantly outperformed stocks of smaller, less profitable (not profitable) speculative companies. For example, stocks of profitable companies like Google (GOOG), Microsoft (MSFT) and Apple (AAPL) far outperformed Hubspot (HUBS), Roblox (RBLX) and Beam Therapeutics (BEAM), all three with negative earnings. The expectation of rising rates helped reduce stock market speculation.

There are two pieces of good news to take away from this. The first is the expectations for rate hikes are now aligned with the reality of rate hikes. The stock market is less likely to suffer from negative rate hike surprises relative to expectations going forward. The second piece of good news is with the price correction, stocks may have bottomed and are beginning to rise even as rates move higher.

The chart below shows the performance of the NASDAQ 100 ETF (QQQ) relative to the 2-year and 10-year U.S. treasury rates. Since the Fed rate hike on March 15, interest rates increased and the QQQ is up near 12% from the March 14 closing price.”

Performance of the QQQ relative to the 2-year and 10-year U.S. treasury rates

The positive stock action since the rate hike may suggest Federal Reserve rate actions have been priced in and the worst is behind us.

Market Update

Investors came into the week looking for confirmation that the market correction might be over. Monday brought no such resolution as stocks closed with modest losses. However, the Nasdaq had been down almost -1.5% midday before substantially cutting the loss by the close. Oil prices zoomed +7% higher fueling another leg higher in energy stocks. Fed Chair Powell continued his inflation-fighting tone in a speech Monday, another new dynamic for investors to consider. Tuesday saw investors welcome the tough talk pushing shares +1% higher. Stock indexes gave back those gains Wednesday as oil prices shot higher once again, crossing $120 per barrel. A breakout in semiconductors Thursday sparked a move higher in the broad stock market. Semis are considered a key growth stock group. Growth stocks have suffered the brunt of the selling this year as interest rates have risen. The jump in semi stocks further encouraged bullish investors that the worst of the market weakness could be over. Stocks traded flat most of Friday until an end-of-day pop left markets higher by +0.5%.

Stocks added a second positive week to their nascent uptrend with the S&P 500 (SPY) closing higher by +1.84%. The Nasdaq 100 (QQQ) rose +2.36%. Smallcaps (IWM) held flat with a -0.36% move.

Warm wishes and until next week.