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The US stock market has suffered its worst start to the year since the global financial crisis, as the threat of rising interest rates, slowing corporate earnings growth and geopolitical tensions sent stocks tumbling across the board.
The S&P 500 index fell 5.3 per cent in January, its biggest monthly decline since the onset of the coronavirus pandemic in March 2020 and the weakest January since the depths of the global financial crisis in 2009.
The blue-chip benchmark had been on track for an even poorer performance — last week it was nearing its worst January on record — until a 4 per cent recovery in the final two trading days of the month on Friday and Monday.
But despite ending on a firmer footing, investors are bracing for more volatility.
The leaders of the fund manager Franklin Templeton’s multi-asset division, for example, normally meet once a month to adjust how much they allocate to different types of assets. But they decided to start meeting weekly to ensure that they can respond quickly enough to volatility.
“It’s going to be that type of year — we believe it’s going to require a more nimble approach to asset allocation,” said Wylie Tollette, Franklin Templeton Investments’ head of client solutions.
January’s sell-off started in the technology sector, where many companies could be adversely affected by rising interest rates. The Federal Reserve has been sending hawkish signals in response to spiralling inflation. Last week Jay Powell, chair, indicated that a first rate rise in March would be all but certain, and he refused to rule out an aggressive sequence of increases to follow.
Higher rates reduce the value that investors place on future earnings, hitting the prices of companies that advertise themselves to investors with promises of longer-term growth. The tech-heavy Nasdaq Composite index fell 9 per cent, its worst one-month decline since November 2008.
As US companies report their fourth-quarter results, earnings growth is also expected to slow after last year, when they were boosted by comparisons with a weak 2020.
While investors have been weighing up rising rates and slowing growth for months, the past few weeks have also added an additional complication: the threat of war in Ukraine.
Geopolitical risks are notoriously difficult to price into stock markets, but several investors said rising tensions over a potential Russian invasion had helped to spread weakness from technology stocks to the broader market in the second half of the January.
“The Ukraine situation is what made it go from something that was really focused on rate-sensitive areas to more of a risk-off sell-off,” said Tim Murray, capital markets strategist at T Rowe Price.
Even without a war, a prolonged stand-off including potential sanctions on Russia could further push up global energy prices at a time when economies are already struggling to tame inflation.
Sebastian Raedler, head of European equity strategy at Bank of America, said “the growth cycle in Europe looks particularly vulnerable because energy prices have gone up so much, which is set to weigh on industrial activity”.
So far, however, European markets have fared marginally better than the US, slipping 3.8 per cent since the start of the year. The FTSE All-World index fell 5.6 per cent, its worst start to a year since 2016, when markets were roiled by concerns about growth in China.
Once stocks had started falling, it was harder than usual for them to stop, according to Jack Caffey, a portfolio manager at JPMorgan Asset Management.
Years of steady share price rises have discouraged portfolio managers from holding even small amounts of cash, lest they miss out on gains and risk criticism for underperforming benchmark indices.
“Markets in the US have become one-way in nature — momentum is a powerful thing,” Caffey said. “We’ve taken away people’s ability to be contrarian . . . the less cash you hold, the more your ability to take advantage of dislocations is challenged.”
Still, despite the challenges, the underlying US economy still appears to be in decent shape. Corporate earnings growth may be slowing from last year’s peaks, but is still expected to remain positive for most large companies, and investors are looking for opportunities amid the volatility.
JPMorgan’s Caffey was among those who highlighted mature tech companies that they believe will be more resilient to inflation and can benefit from longer-term trends such as rising demand for semiconductors, rather than temporary pandemic-era boosts to their business.
Others including Murray at T Rowe Price said they were focusing on smaller companies and “quality” stocks that tend to have more stable earnings and stronger balance sheets.
“Whenever you get a real sharp market reaction, you have some babies being thrown out with the bathwater,” Murray said. “There are certainly some out there.”
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