After starting the new year at all-time highs, the U.S. stock market experienced a bout of volatility. U.S. stocks fell about 9% peak-to-trough based on closing prices. The tech-heavy Nasdaq 100 Index fared even worse with an intramonth drop of about 15%, before recovering slightly and reducing the decline to 9%. Other benchmarks which have lagged the broad U.S. market in recent years suddenly held their ground quite well. Developed-market foreign stocks fell only 5% and emerging-market stocks fell a mere 2% for the month.
The pain of equity losses was even more acute in both speculative companies without profits and technology companies trading at very high price-to-earnings ratios. Netflix, Peloton, and Tesla, for example, were down 21-36% at one point during January. This contrasts with relatively unloved stocks, such as those in the utilities sector, which only fell about 3% as a group. Bonds were also under pressure. The U.S. aggregate bond market was down 2% in January, affirming our current defensive approach to the bond market.
The losses in bonds can be directly attributed to the rise in interest rates that began around the beginning of the year. But the explanations for the losses in the stock market are more complex. It’s true that a sharp rise in interest rates served as the initial trigger for the stock market decline, but when rates ceased rising, market losses continued. In fact, over several consecutive trading days, long-term U.S. interest rates fell, but the global stock market continued giving ground. Corrections happen for many different reasons and interest rate increases are just one of them.
Remarkably tame market conditions in 2021 add a sting to January’s volatility. Sustained calm makes it easy to forget what is normal. On average, the market experiences at least one correction each calendar year, but 2021 did not present one. In some ways, January’s correction is a correction deferred. It could last longer if inflation remains sticky and if the Federal Reserve responds by restricting economic activity. As mentioned before, the overvaluation of many stocks adds to that possibility. However, it is a mistake to overlook the strength of the U.S. economy. The unemployment rate is now under 4%, and U.S. GDP grew by 5.7% during 2021, the largest annual increase since 1984. Most companies are matching or beating their earnings targets. This potent mix of factors suggests the long-term trajectory of the market is a positive one.
We wish you a happy and healthy new year. Please reach out if we can be of service.