What A Rocky First Week Spells For Markets In 2022

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By Michael Fredericks

Investors returning to their desks after a peaceful holiday are likely to have been jolted by the crisis in both the equity and bond markets at their desks.

Federal Reserve officials signaled an even faster schedule for rate hikes, causing 10-year Treasury yields to soar and hurt equities — particularly more technical, speculative names.

For investors, 2022 may look bleak at first glance. Powerful forces that have propelled stocks to all-time highs now appear to be on the verge of disappearing. To older generations (or false hipsters in the current one), this might remind you of the shrill noise a turntable makes when the needle stops abruptly on a favorite track.

So what should income investors do in this world poised for regime change? They have to develop a complicated relationship with the quality of their wealth. Basically, you should focus on quality in the stock markets. On bonds, be more willing to exit selectively.

We also believe we are likely entering a phase where no single trade or asset will dominate, meaning investors can benefit from spreading their chips across different markets. Will 2022 bring a fourth straight year of double-digit returns in global equities? Possibly. But will a handful of tech titans again account for a third of the S&P 500 Index’s gains? I am very doubtful.

It was only in January that we saw the fragility of such a narrow focus on growth. In the first week of 2022, about 40% of stocks traded on the Nasdaq were 50% or more below their one-year highs.¹ And the Fed’s actions in 2022 could further dampen appetite for highly valued, speculative companies.

Because of this, our team seeks to invest in areas of the stock market that have been left behind. In fact, a surge in volatility can be an opportunity to buy dividend stocks that have consistently demonstrated higher profit margins and reliable revenue streams — traits that can also help them weather inflationary pressures.

As for the bond market, our portfolios are minimally invested in government fixed income and investment grade bonds. In the case of high yield, the picture is somewhat more difficult. As we get later in the business cycle, the additional compensation investors get for bonds when they degrade becomes smaller. Our team has focused on selecting high yield credit from companies that we believe will prove resilient in the next economic crisis or recession.

We have also gradually increased credit versus bonds to demonstrate our preference for a higher position in the same company’s capital structure. Bank loans can also offer resilience to rising interest rates because their coupon payments adjust relative to short-term interest rates.

All in all, it seems to me that at the start of a new year, investor conviction is low. As mentioned, this is likely related to expectations for higher interest rates and less liquidity this year. Many investors believe that the long period of ultra-loose global monetary policy that has accompanied us may be coming to an end.

The subdued mood in the markets is also likely related to a tiredness of predicting the path of the ongoing pandemic. With that in mind, my team believes the first line of defense in 2022 will be discipline and selectivity. It doesn’t have to be the end of your favorite song. We just need to reset the vinyl for the next track.

1 Source: Bloomberg, January 10, 2022.

This post originally appeared in iShares Market Insights.

Publisher’s Note: The summary points for this article were selected by Seeking Alpha editors.

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