Who Removed The Easy Button?

Current State of the US Markets 

The US financial markets entered a period of heavy turbulence at the end of November 2021 that lead to a significant decline in U.S equities over the following 3 months. At the time of writing, US-listed equities have seen the indiscriminate P/E compression of future cash flow-dependent businesses as stock prices continue to plummet in the wake of macroeconomic and geopolitical shifts. Let’s explore the three main catalysts causing this most recent stock market correction. 

Inflation

Inflation has seen a steady increase over the last 6 months as Consumer Price Index data continues to show month after month increases in the costs of goods and services. With inflation currently sitting at over 7%, many investors are rightly concerned about what this means for the short-term future of the stock market.

Typically, growth stocks do not perform well in high-inflationary environments and so many investors are now looking to rotate into more defensive portfolios. This rotation has led to growth and tech stocks falling in value as more investors continue to flee to the relative safety of dividend and value stocks. 

Monetary Policy 

With inflation continuing to climb, the U.S Federal Reserve has little choice but to explore its options to try and control the situation. Its main weapon to combat inflation is its ability to raise interest rates thereby making it more expensive to borrow money. As money becomes more expensive to borrow, less of it is spent within the economy which leads to lower inflation. 

Naturally, this harmed stocks that are reliant on borrowing to fund the continued growth of their businesses. As a result, the prospect of interest rates increasing is further compounding the compressing valuations of U.S growth stocks who are largely reliant on access to borrowing. 

While a number of rate hikes are expected in 2022, it is not known how many rate hikes the Federal Reserve will implement in an attempt to control inflation. This uncertainty further exacerbates an already fearful market. 

Conflict 

Lastly is the specter of war that has been looming on the horizon. As many of you reading will already be aware, there are grave concerns over the situation on the Russian/Ukrainian border. The financial markets tend to be forward-looking and always attempt to price in the impact of possible future events into the valuations of listed equities. 

 The prospect of a conflict with Russia is an especially negative event that will inevitably lead to widespread hardship and a weakening U.S economy. As a result, the US markets are currently showing significant fear over the movements of Russian troops across the border. If tensions continue to escalate, it is likely this catalyst will continue to have a detrimental impact on the US stock markets.

Conclusion

Trading or investing in these market conditions can be especially difficult for those participants who are less experienced in the financial markets. For many new investors, this may be the first time they experience a meaningful correction since the short-lived crash of March 2020. If you count yourself among these fearful few, perhaps you will take solace in the fact that like all corrections before it, this one too shall pass.