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FBB Insights

Volatility Returns

Dear Clients and Friends,

It’s been an interesting start to the calendar year, with Omicron cases spiking, the Federal Reserve threatening to tighten monetary conditions, and stocks moving all over the place, but
generally down. The broader market fell ~4% on Monday, but raced back to a modest gain, although stocks Tuesday morning are back down. Our last quarterly update asked if 2022 would be the fourth year in a row of big performance for blue chip U.S. stocks, but January is setting a higher bar for markets to clear.

Factors driving the volatility

What’s going on here and what does the rest of the year have in store? Let’s explore a few of the themes impacting markets and lay out the knowns and unknowns. We can start with a simple
explanation of why markets, and especially high growth stocks, are declining. Interest rates, including 10-year Treasury yields, have surged this year, making bonds just a bit more attractive
than stocks.

In particular, expensive growth stocks, which promise big profits sometime in the future, look even worse compared to safe and growing bond coupons paid to investors now. Using this logic, we are seeing a simple rebalancing out of high growth stocks as bonds look more compelling. Under this scenario, if bond yields stabilize or even fall, we could see growth stocks recover in the balance of the year.

But what if there are more complex factors driving the market volatility? A more pessimistic and perhaps holistic view might look at the highest inflation since the 1980s and then anticipate a
swift and crushing response from Jay Powell at the Federal Reserve, which happens to have an update on monetary policy on Wednesday afternoon. This bearish view might expect the Fed to tighten up the economy, which may depress corporate earnings and then lead to even more pressure on stocks.

So, what’s the best plan of action for long-term investors? While big market corrections are never pleasant, they are part of a historical pattern of 10% declines roughly every nine months.
Fortunately, we’ve avoided this type of correction since March of 2020, but this kind of volatility was overdue.

What happens after a market correction?

If history is a guide, broader markets generally perform well coming out of a 10% decline, with stocks up 10- 15% in the year following the correction. We are monitoring a variety of macro data
and evaluating upside and downside scenarios from here, but in general we prefer to stick with full equity allocations for three reasons:

  1. We see steady, though modest economic growth ahead.
  2. Despite Federal Reserve tightening actions, interest rates will likely remain low enough to support companies and the economy.
  3. The recent correction has made many stocks look less expensive.

In the short term, we are taking advantage of the market choppiness by making modest additions to our holdings in growth companies that have corrected. As we move ahead in 2022, we will continue to monitor these themes and their impact on the economy, corporate profits, and stocks. This year’s volatility may help us uncover additional investment opportunities that meet our core investment principles, remaining ever mindful of your goals and objectives.

We wish you all the best this Winter season.

Michael Bailey, CFA
Director of Research

Michael Mussio, CFA, CFP®
President

 

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