It is beginning to look as if 2022 is going to be the worst year for stock market investors for more than a decade.
US equities have led the downward trend, particularly the Nasdaq, which has fallen most heavily due to the tech stocks that dominate it being more heavily beaten up.
Monday night, though, saw the S&P500, a far broader US stock index, join the Nasdaq in entering bear market territory, in other words, falling by more than 20% from its most recent peak.
The Nasdaq itself first entered bear market territory on 24 February, the day Russian President Vladimir Putin launched his war on Ukraine, while another key US stock index, the Russell 2000 – which tracks the performance of smaller US companies – slipped into bear territory at the end of January.
But the slide of the S&P500 into this territory highlights the extent to which investors in some of America’s biggest companies are now pricing in a much gloomier economic outlook. The more narrowly focused Dow Jones Industrial Average remains some 17% below its more recent peak while the Nasdaq is currently languishing at its lowest level since September 2020.
Some individual S&P 500 constituents have, of course, fallen by far more than the index itself – many of them tech stocks. Netflix is down by 72% since the start of the year, the e-commerce group Etsy is down by 67% and PayPal, the payments group, by 61%. Away from the tech sector, the gaming group Caesar’s Entertainment is down by 58% since the start of the year while the retailer Bath & Body Works is off by 53%. Other notable fallers include the sports apparel business Under Armour and the cruise line operator Carnival, which are both down by 51%, the asset manager T Rowe Price, which is down by 45% and the toolmaker Stanley Black & Decker, which is down by 44%.
It is true that the US is not alone in suffering poor performance this year. Among other leading stock indices around the world, the Nikkei 225 in Japan is down by 7.5% so far this year, the Hang Seng in Hong Kong and the Shanghai Composite in China by nearly 10%, the DAX in Germany by 16% and the CAC-40 in France by 17%. Only the FTSE-100, which has fewer tech stocks and whose ‘defensive’ make up means it has underperformed its peers for many years, has largely avoided the rout among major indices. It is down by just over 3% so far this year.
The more extreme falls experienced by US markets are down to one major factor – that the Federal Reserve is raising interest rates more rapidly than its counterparts such as the European Central Bank, the Bank of England or the Bank of Japan. The Fed, which like other major central banks had kept the cost of borrowing at close to zero throughout the pandemic, raised its main policy rate, the Fed Funds Rate, from 0-0.25% to 0.25-0.5% in March and followed this by taking it to 0.75-1% last month. So far so good – a quarter-point and a half-point increase, with Fed Funds still at historically low levels, was not going to frighten the horses unduly.
Then came last Friday’s US inflation figure. It had been assumed that inflation had peaked in the US in March, when it touched 8.5%, after it declined to 8.3% in April. A rise back to 8.6% in May was completely unforeseen by Wall Street and has raised the spectre that the Fed will increase its main policy rate by three-quarters of one per cent – something that has not happened since 1994, itself a tumultuous year. Wall Street sold off on Friday and the rout continued into Monday. The figures have reinforced concerns among some investors that the Fed, just as it was in the early 1980s, is now more worried about bringing inflation under control than it is about sparking a slowdown in the US economy.
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Concerns played out in bond market as US dollar hits records
Those concerns are also being played out in the bond market. The yield (which rises as the price falls) on US Treasuries (US government IOUs) hit their highest level for more than a decade on Monday, with the yield – effectively a measure of US government borrowing costs – on 10-year Treasuries hitting 3.44% at one point, a level last seen in 2011. The yield on five-year Treasuries at one point hit 3.581%, a level last seen in July 2008, when the global financial crisis was raging. The yield on two-year Treasuries, meanwhile, at one point hit 3.417% – a level last seen in December 2007.
Treasury yields may sound to the uninitiated like some esoteric measure, only of interest to financial market professionals, but they are hugely important because they are a clue as to what investors think of prospects for the US economy. In this case, they are highlighting the concern among investors that inflation is becoming entrenched. Treasury yields also have a huge influence on other types of investment, such as stocks, as they are seen usually as such a safe investment.
Something else happened yesterday in the US Treasury market that will also be of concern to the wider investment world – the yield curve, in the jargon, briefly ‘inverted’. Normally, the longer-dated a bond is, the higher will be the yield on it as investors demand a greater return for keeping their money tied up longer. On Monday, though, the yield on 2-year Treasuries rose above the yield on 10-year Treasuries. In other words, investors are demanding a greater return for the risk of having their money tied up in US government bonds over the next two years than they are for holding those assets over 10 years, indicating that they think interest rates are going to rise sharply in the near term. Yield curve inversion is, traditionally, an accurate predictor of a looming recession because it frequently disrupts the way banks – which like to borrow short and lend long – make credit available. It makes the banks more reluctant to lend money.
Other markets are also showing signs of investor unease over the macroeconomic outlook. The US dollar, a traditional safe-haven, has attracted buying and has been hitting all sorts of records against a number of currencies. For example, it hit its highest level against the Japanese yen for 24 years on Monday, while against a wider basket of currencies, which includes the pound, it is trading at levels not seen for 20 years. This, too, poses all kinds of challenges for the global economy. A strong dollar creates particular problems for emerging markets because it sucks capital away from them and towards the US. It also pushes up the cost of importing dollar-denominated commodities, such as oil and some foodstuffs, just at a time when these items are already in more scarce supply in some cases due to the war in Ukraine. It also causes problems for some big American multinationals. Microsoft is merely the latest to highlight how its earnings will be hit this year by the strength of the dollar – which pushes up the cost of its products and services in overseas markets and also erodes the worth of profits made in other currencies when these are translated back into dollars.
Havoc wreaked in cryptocurrencies
And then there is the havoc being wreaked in cryptocurrencies. These were already reeling from a loss of investor support after the collapse of the so-called ‘stablecoin’ TerraUSD and their claim to remain a store of value at a time of high inflation has been, to say the least, called into question. Bitcoin, the best known, is down by almost 70% from the all-time high it hit in November last year and other cryptocurrencies have similarly struggled. This is having repercussions in the wider crypto ecosystem: the cryptocurrency exchange Coinbase announced today it was cutting 1,100 jobs – some 18% of its workforce – as it seeks to save costs.
Brian Armstrong, the founder and chief executive of Coinbase, noted: “We appear to be entering a recession after a 10+ year economic boom.”
That remains debatable. But what is beyond debate is that some assets, like crypto, and some business models, particularly in the tech sector, have never been tested through a protracted period of inflation. Companies like Amazon and Netflix were not around when US inflation was last this high – while we are now about to find out the extent to which demand for their products and services will be hit in an environment in which, after a decade and a half of near-zero interest rates, higher borrowing costs threaten to have an impact on numerous parts of the economy.