It was a rough start to the year for equities, and it puts an abrupt end to a three-year rally in the markets.
The Dow Jones Industrial Average fell more than 700 points on Monday, down more than 2%, and was heading for a seventh consecutive daily decline.
It was even worse for the S&P 500 and the Nasdaq, which also fell on Monday and are now both down more than 10% each from their records – a fall known in the markets as “a correction”.
Cryptocurrencies were not spared the rout, with Bitcoin down 5% to around $34,000.
Concerns about rising tensions in Ukraine, where Russian troops are massed at the borders, contributed to the decline.
But ultimately, fears are fueled by the recent surge in inflation to 40-year highs, which will force the Federal Reserve to raise interest rates in order to cool prices.
Why the outlook is so uncertain
How the Fed goes about it is tricky, though.
Higher interest rates will drive up borrowing costs for consumers and businesses, and investors are trying to figure out how much that will affect businesses.
Raising rates too much could slow the economy excessively. Yet raising them too little raises the opposite concern that they will not bring inflation down too much.
For now, Wall Street expects the Fed to raise interest rates four times this year, potentially as early as March. At some point, the Fed is also expected to start selling assets — including bonds and mortgage-related securities — it bought during the pandemic to support markets and the economy.
In a new research note, economists at Goldman Sachs said they expect the Fed to raise interest rates four times. But they added a caveat that the Fed could raise interest rates more aggressively if inflation remains high, a process known in markets as policy tightening.
“We see a risk that the FOMC will want to take tightening action at every meeting until this situation changes,” Goldman said in a note, referring to the Federal Open Market Committee (FOMC), the group that takes the decisions on interest rates à la Nouris.
Tech companies are being routed
Interest rate uncertainty has hit technology companies particularly hard, including Meta, the parent company of Facebook, and Alphabet, owner of Google.
Tech company stocks tend to do better in high-growth economies and less so when rates start to climb.
Inflation is also eating away at future earnings, and investors are recalibrating their expectations after soaring tech stock prices over the past few years.
Of course, it is difficult to predict the path of inflation, which means that the uncertainty in stock markets could continue for some time.
Most analysts still expect stock markets to gain this year after rising in each of the previous three.
But the gains might not be as big as in recent years. Stocks actually surged during the pandemic as consumers went on a shopping spree, while millions of amateur investors hit the markets for the first time.
Much of what happens will depend on how inflation, the economy and corporate earnings progress.
The Fed meets on Tuesday and Wednesday, and Fed policymakers are expected to share new details on their interest rate hike plans, although no significant action is expected.
On Friday, the Commerce Department is expected to release several economic indicators, including consumer spending and inflation.
Meanwhile, a slew of companies, including Microsoft and Apple, are set to release earnings for the last three months of 2021 this week, and investors will be eager to see how corporate earnings have held up during a period marked by inflation. high, supply chain and staffing issues. shortages.
Michael Wilson, chief U.S. equity strategist and chief investment officer at Morgan Stanley, said he would pay close attention to how each company is performing and how executives are managing higher costs.
Like tech companies, stocks that have been pushed higher by speculation could continue to fall, he said.
“The scum is coming out of a stock market that has simply overextended on valuation,” Wilson wrote in a note to clients.