The start of 2022 was notable for the absence of the January effect—the tendency for stock prices to rise in the first month of the year. Over the month, US Small Cap sold off nearly 10%1, registering the second worst January since 1980, and US Large Cap sold off more than 5%, the fourth worst showing in more than four decades. As a result, valuations have improved, especially in the technology sector and late stage venture capital. Broad equity factors have undergone material repricing with value outperforming growth across market capitalizations, led by energy and financials.
Equity selloffs—especially in sectors with higher interest rate sensitivity—reflect investor concerns about the increasingly hawkish stance that central banks are adopting. The market is now pricing in more than six 25-basis-point hikes in the US federal funds rate in 2022. But despite the near term challenges, markets appear sanguine about the longer-term outlook. The 20-year to 30-year part of the US Treasury curve remains stubbornly flat to slightly inverted, signaling a likely return to low inflation and at- or below-trend growth over the long run. Five-year-forward of 10-year Treasuries are still trading around 2.4%, 5y5y inflation breakevens are trading around 2.1%, and the breakeven curve is still deeply inverted. Put another way: the market environment remains moderately constructive for risk assets.
Corporations still have access to easy financing at low rates and defaults have remained low as well, helping to mask any increased idiosyncratic credit risk. Still, the VIX, the “fear gauge” for the S&P 500, has been elevated, having closed at 31.96 on Jan. 26 as the selloff intensified and credit spreads widened. Equity dispersion is increasing as the earnings season progresses, with markets forced to absorb the impact of macro uncertainties along with the steady flow of beats and misses at the company level.