Weekly Review
The S&P 500 fell by -2.21%
The Dow Jones Industrial Average shed -1.28%
NASDAQ Composite dropped by -4.13%
Russell 2000 lost -2.15%
The Market had its worst first half to a year since 1970, as high inflation has prompted the Federal Reserve to raise baseline interest rates at the fastest pace since the 1990s.
Since peaking on January 3rd to start the year, the S&P 500 has lost over -20%, falling into a bear market. The tech-heavy NASDAQ composite has dropped nearly -29%, while Bitcoin has plunged by -58%, leading to losses for many retail investors.
But rewinding the clock to a year ago, we had a very different outlook on what 2022 would hold. In the summer of 2021, Wall Street was highly optimistic about a sustained period of growth as a widespread vaccination campaign helped usher in an economic reopening following the depths of the Pandemic.
Investors were giddy over the prospect of pent-up consumer demand leading to one of the most robust economies of the post-World War II era. While inflation had started to creep up to 4% by April 2021, the Federal Reserve dismissed it as transitory and focused instead on bringing unemployment to pre-pandemic levels.
And for a while, it was self-fulfilling—the Market peaked on January 3rd, 2022, 40% higher than its high before the Pandemic, and unemployment is currently at 3.6%, virtually where it was in February 2020. But inflation this year has yielded a different type of beast, one we haven’t seen in over 40 years.
In short, cheap money made everything in higher demand over the past decade. But now, global-driven inflation finally caused the system to stall, as the past decade finally caught up to our excess. And as the saying goes, "the bigger they are, the harder they fall."
How did we get to the peak?
The Market's rise in the 2010s through the start of 2022 is a story about money in the system. Since the Global Financial Crisis in 2008-09, the US economy has come to rely heavily on historically low-interest rates.
As the US cut rates in the early 2010s to combat the deepest recession since the Great Depression, the Market became dependent on a steady inflow of capital to push prices higher. Additionally, the rise of the FAANG class of mega-tech companies created a new expectation that all fledgling tech companies could become global multi-billion-dollar businesses.
Wall Street became far more willing to pay for the promise of growth over the reality of profitability. And we all came to accept the frothiness of the times as we marveled at valuations, with new idioms like TINA (“there is no alternative [to stocks]") and "LFG" becomings justifications for the bubble.
This new muscle memory flexed itself mightily during the Pandemic, as $5 trillion in cash from the Federal Reserve moved into circulation, and interest rates dropped to near zero. American consumers shifted their spending habits to inside their homes and online, spurring the most profitable corporate quarter on record in Q4 2021.
With investors flush with cash and backed by an accommodating Federal Reserve, tech IPOs minted new billionaires overnight. At the same time, cryptocurrencies and Special Purpose Acquisition Companies (SPACs) drew capital of all types into the riskiest of assets with the allure to get rich quickly. Until just six months ago, life in the Market was very good.
So what went wrong?
Oh, what a year it has been. First, it was the variants with Delta and Omicron blazing through the US in the second half of 2021, causing a new round of disruptions and civil division. As countries worldwide struggled to vaccinate their populations, the global supply chain became choked with bottlenecks, failing to keep pace with global demand for more stuff.
Then 2022 macro events whacked the US like a hammer, as Russia's invasion of Ukraine shocked commodities markets, driving the price of oil, commodities, and natural gas through the roof. As energy is a critical input into everything else, companies have passed price increases onto consumers, resulting in inflation surpassing 8.5%, the highest since the 1980s.
Initially slow to act, the Federal Reserve was caught flat-footed and sharply tightened its monetary policy to combat runaway inflation. As a result of higher interest rates and the Federal Reserve pulling money from the economy in the form of asset sales, the Market has seen a steep drop that has seen both equities and bonds fall by double digits this year.
Now, negative consumer and business sentiment has started to stack, making a recession this year seemingly inevitable. Slowing demand and higher costs have begun to erode both growth and profitability for companies—a painful combo for valuations.
Investors, from asset managers to venture capitalists have rediscovered temperance and financial restraint, cutting the music on the world’s largest party.
So can the Market recover in 2022?
it depends on how you define recovery. In order for the S&P 500 to reclaim its January 3rd peak In the next six months, it would need to gain 25% from now through the end of the year. Given all the macro drivers that have stacked up against dispelling inflation, this will be a tall task for investors that have been battered by the false rally in March.
That isn’t to say that the Market can’t return positive gains in the back half of 2022. But this year likely won’t end positively with investors worried about continuing downside risk as the Federal Reserve sees if its policies can reign in inflation.
Weighting a recession at only 30% in March, economists now fear a downturn could be long-lasting, as the Federal Reserve will keep interest rates elevated so long as inflation remains above its target of 2%. Unlike past recessions, the Federal Reserve isn’t coming to the Market’s rescue with the nectar of cheap credit.
But as the Market grapples with its newfound reality, the only catalyst for a full market recovery will be a clear line of sight to the end of interest rate hikes.
With energy prices likely staying high due to the decoupling of Russia from the global economy, it could yet take quite a while for the inflation to slow and the Market to regain confidence.
All that being said, we have history on our side. Over the long run, major market indexes will recover, but we’re likely facing a long slog back up the mountain.
Stay frosty. Below are this week's top movers.
Weekly Gainers and Losers
These were some of this week's biggest ETF Gainers:
S&P 500 Utilities Sector SPDR (XLU): +4.12%
In a signal that Wall Street is anticipating a recession, utilities gained this week as investors flee to recession-safe havens. While consumers shed discretionary spending on new stuff in a downturn, utilities like electricity providers are one of the few sectors with stable demand.
Hong Kong Ishares MSCI ETF (EWH): +3.17%
As part of its zero-COVID policy, China has faced a rough few years as its tourism industry cratered due to a multiweek quarantine policy for visitors. But this past week, China announced it would shorten traveler quarantine to one week, boosting battered cities such as Hong Kong.
20+ Year Treasury Bond iShares ETF (TLT): +2.90%
Although prices for treasuries have fallen this year due to rising interest rates, investors are starting to make their way back into the asset class as recession fears grow. During market downturns, bonds historically outperform equities as investors flee to the safety of government-guaranteed securities.
These were some of this week's biggest ETF Losers:
ARK Fintech Innovation ETF (ARKF): -11.20%
The high-flying ARK funds, which rose mightily during the Pandemic, have had a devastating year, with ARKF losing more than -61% year to date. Investors have soured on fintech innovators, such as Coinbase and Robinhood, as higher capital costs have pulled retail investor demand out of the Market.
Semiconductor iShares ETF (SOXX): -9.56%
As a critical piece in the past decade's digital transformation, semiconductors are facing a grim outlook as the global economy cools. Having dealt with supply shortages over the past two years, chip manufacturers now see slowing demand as consumers pull back on new phones, cars, and crypto mining rigs.
Proshares Bitcoin Strategy ETF (BITO): -9.12%
As retail and institutional investors flee cryptocurrencies, Bitcoin slogs through a cold winter. A slew of high-profile decentralized finance protocol failures, such as Terra and Celcius, has caused the equivalence of a bank run on crypto, as even long-term holders have started to sell their positions in favor of cash.