US stock market continues to fall

What's going on: figures, facts

Unlike the Russian stock market, where everything is clear — geopolitics is destroying the ruble and the stock market, the American fall was purely an internal matter caused by the state of affairs in the American economy itself. The period of instability and extreme volatility began on the stock markets in November 2021. The main driver was the Fed's announced decision to curtail the stimulating monetary policy due to rising inflation, plans to raise the key rate at a faster pace (than expected) to combat it.

Geopolitics didn't play as big a role then as it does now. They were more afraid of the spread of a new strain of coronavirus and the possibility of introducing new lockdowns, which, as we know, sent the entire world economy into a deep knockdown in 2020 and the pieces of which we are still picking up around the world — inflation is raging, logistics is malfunctioning, there is a shortage of products of various types and much more.

Since the beginning of the year, S&P 500 index has already dropped by 11%, constantly entering the correction phase. Technological Nasdaq 100 dropped by 11,78% (already in correction), and Dow Jones — by 3,56%.

It should be understood that in 2022 there were only 17 trading days on the market. This is a record of such a rapid decline in more than 90 years. Never before has the American market started the year with such a sharp drop. All investors were waiting for the Fed's statement in the hope of understanding the policy regarding the timing and pace of raising the key rate to combat inflation.

Reasons for the ongoing decline:

1. Increase in the key rate. Why is it so important? The answer is very simple — it is used to discount (that is, bring to a value in the current time) the amount of future revenue of companies whose shares are traded on the stock exchange. The higher it is, the lower the amount of revenue is. As a result, the company's valuation is lower, which automatically leads to a revaluation and reduces the calculation of the share price. It is expected that the Fed will not raise the rate immediately, will announce a series of increases starting in March. The question is how many upgrades there will be and to what levels. It is obvious that there will be a tightening of the monetary policy, since the Fed was rebuked by the US government for the failure in the fight against inflation — no one wanted to admit the problem, considering it temporary. A tough policy will put pressure on the stock market and hinder its recovery. This particularly affected the high-tech sector, as there was a rapid growth in revenue and plans for it, which are now discounted, and the shares are overvalued. Investors are leaving this sector and shifting to the fuel and energy sector, as the conjuncture of this market allows us to look with confidence into the medium-term future. On the eve of the rate hike, the yield on 10-year US Treasury bonds is growing, it has already exceeded 1,85% for the first time since the beginning of the pandemic. At the end of 2021, the Fed stopped buying Treasury bonds as part of the curtailment of the economic stimulus programme.
2. The release of companies' reports for the 4th quarter of 2021. The reporting season is coming, the financial results of companies are published. The overall mixed results affect investor sentiments, adding even more volatility on trading days. At the same time, more than 70% of S&P 500 companies showed results that exceeded expectations. But such leaders of the sectors, such as, for example, Netflix and Goldman Sachs investment bank, turned out to be lower than predicted.
3. Geopolitics. This is a new factor in the equation. The geopolitical tension in the Ukrainian direction brings nervousness to the camp of investors, the hypothetical possibility of a large-scale war in Europe makes many investment fund managers (especially those who are engaged in pension savings) fix the results of the good (even, one might say, excellent) 2021 year for the stock market. Interestingly, the leaders of the fall were mostly companies that produce semiconductors or widely use chips in their products (for example, NVIDIA, Lam Research, Applied Materials). It is worth noting that the latest addition to our model portfolio have been just the securities of such companies. According to experts, one of the reasons for the fall in the quotations of these companies could be a potential ban on the export of chips and electronics to Russia.

Forecasts of the development of events

Two-day meeting of the Open Market Operations Committee (FOMC) of the Fed ended the night of 26 January, decisions and comments are to be announced. For sure, it will be about raising the rate in March by 50 basis points at once. Everyone is waiting for a comment, as it will make it clear whether this will calm the markets, and it will give more hints that it can force the Fed to start an earlier and faster normalisation of the balance.

There is an opinion that the valuation of shares will decline faster than expected, due to the rate increase not three times in 2022, but four, and by a larger amount. This could lead to a more serious sell-off in the first half of the year. It is worth noting that if the S&P 500 declines by 20% from the levels of the beginning of the year, the index will fall to the level of 3830 points and will lose all growth from March 2021. The target level for the S&P 500 index is projected at 4,400 (now 4,433) points by the end of 2022. Against the background of high inflation, the yield of 10-year bonds may also rise to the level of 2,1%.

If such forecasts are really real, then we should fix our model portfolio after some time, after the inevitable rebound upward. It is worth keeping a close eye on the market at the moment. There is an understanding that the market is overvalued in terms of the P/E ratio (the ratio of the market value of a business to its profit). Health care and consumer goods sector can act as protective sectors.

In general, in terms of the state of the global economy, the IMF lowered the forecast for global economic growth for 2022 to 4,4%, due to weak prospects for China and the United States and rising inflation. The fund also expects that the Omicron strain will cease to put pressure on growth in the second quarter of 2022.