After such a calm year, 2022 has been a rude awakening. It has been a rough start to the year. While the month isn’t over, January 2022 is shaping up to be one of the worst months we’ve had in the markets for a while. Currently, the S&P 500 is down 10% from the highs, what market technicians call a “correction”. Whatever you call it, it’s the most significant decline since the craziness of March 2020.

This recent spike in “volatility” has shaken some investors. It’s no surprise. Last year we did not see more than a 5% decline. That’s quite rare, given 95% of the time, stocks have seen a loss of at least 5% in any given year1. In fact, stocks have fallen at least 10% in the greater majority of years. So maybe the market is just catching its breath after an unusually tranquil 2021.

The reason for the current sell-off has been attributed to rising inflation and the upcoming interest rate hikes from the Fed. As my colleague Andrew mentioned last week, when interest rates rise, it is more expensive for companies to operate. But the Fed tends to raise rates only when the economy is going well. Historically, the stock market has fared exceptionally well when the Fed has raised rates. In almost every period when the Fed raised rates, the S&P 500 had a positive year. Outside of ‘72-’74, the stock market has handled higher interest rates quite well (see image below). (What happened in 1973-74? We had an oil crisis, the collapse of the Bretton Woods agreements that led to a dramatic devaluation of the US Dollar.)

We think that the current pullback in the market is only a short-term hiccup in an otherwise longer-term global economic recovery. America has been lucky our economy rebounded so sharply last year. Countries like Germany and Japan are still playing catch up; their economies should accelerate this year, not slow down. In a recent survey, global CEOs were the most optimistic in ten years2. These industry leaders have a different perspective on the economy than the typical person. Their views on their various businesses can be an important indication of where they expect hiring, inflation, and capital expenditures will go.

Their sentiment is backed up by the data. One of our favorite gauges of the future of the economy continues to be America’s LEI or the “Leading Economic Indicators”. This collection of data looks at future demand and has been tremendously reliable. Whenever the LEI has turned negative, it usually indicates a recession is around the corner (see red shaded area below). Currently, the LEI continues to be quite steady, despite the recent COVID wave3. As you can see, the LEI index is at some of the highest levels in the past few years.

After such a calm 2021, we are likely in for a rockier ride in ‘22. However, despite all the news headlines of higher inflation and interest rates, many economic data points continue to be solidly positive and continue to show a global economy is on the mend. And while the stock market might go through its emotional gyrations, data show that the global economy is on the right track for the next few quarters and years. Therefore, we will continue to stick with high-quality companies in our portfolios and eschew lower-quality names, especially during these rocky times.

– Benjamin Lau

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