In one of our 2021 blog posts, we spoke about how the S&P 500 had not experienced a 5% drop throughout the year. Eventually, in late September it did, but quickly rallied and finished 2021 with a gain of 26.9%. Unfortunately, the S&P 500 was not as patient in 2022; achieving a 7% drop within the first 15 trading days of the year. Now that we have that out of the way, let’s discuss the recent choppiness of the market. What’s driving it?
Inflation has taken hold after years of historically low inflation readings. The ten years preceding 2021, inflation averaged a 1.73% annual increase in Consumer Price Index, which measures consumer prices for a variety of items including vehicles, gas, groceries, housing…etc. In 2021, the Consumer Price Index measured 7%. Anyone who went to the grocery store, a car lot or looked to purchase a house felt the brunt of this increase. A multitude of factors converged to ignite the increase - money supply growth by the Federal Reserve in response to the Coronavirus Pandemic, supply chain issues related to the pandemic and increased demand; to name a few.
Rising interest rates are another culprit as the Fed prepares to combat inflation by raising interest rates and reducing bond purchases. The 10-year Treasury yield increased year-over-year as of January 19th, 2021 from 1.10% to 1.83%. While this does not seem like much, it equates to a 66% increase. This is prior to the expectation of several rate hikes by the Fed during the course of 2022. Growth-oriented companies that typically aim to deliver profit growth in the future, tend to be more sensitive to rising interest rates, hence the quick decline of the NASDAQ index. This has played out in the beginning of 2022, as the NASDAQ is down over 12% since January 3rd.
With the increased volatility and expectation of higher interest rates, we are positioning the fixed income portion of our model portfolios with a capital preservation mind-set. Long-term bonds tend to react negatively to an increase in interest rates which leads to our preference for shorter-term fixed income securities which are less sensitive to rate hikes.
We will not be making drastic changes as our mind-set remains long-term; especially with the equity portion of our portfolios. We generally view volatility as an opportunity to take advantage of rebalancing to keep your risk in check and instill discipline to stick to a long-term financial strategy. Also, our dividend equity strategy provides somewhat of a relative safeguard to rising rates, inflation, and the exact environment we’re currently in.
As always, if you have questions or concerns about your individual situation, please don’t hesitate to contact us.