- What worked in the stock market in 2021 isn’t working in 2022.
- A rotation out of high-growth tech stocks has been sparked by a hawkish Fed trying to combat inflation.
- Here’s why rising interest rates are inverting the biggest investing themes of 2021 in the new year.
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The new year is off to a rocky start for investors amid a sharp rotation out of high-risk growth and into safer value stocks.
The S&P 500 is down about 4% year-to-date, reversing part of its 27% gain in 2021. The sell-off has been even worse for the Nasdaq 100, which is down 7% year-to-date as of Monday morning, erasing a quarter of last year’s gain.
Weakness in high-growth tech stocks should be no surprise to market observers, given that 2021 was Ark Invest’s worst year since its 2014 inception after speculative stocks peaked last February.
That’s all changing this year, as those same companies are down 8%, 7%, and 4% year-to-date.
The decline comes as Fed Chairman Jerome Powell shifts the central bank’s monetary policy in response to economic conditions. The two main goals of the Fed are to reach maximum employment and to keep prices stable.
After the unemployment rate surged to 15% amid the COVID-19 pandemic, the Fed lowered interest rates in an attempt to stimulate consumer demand and bought various types of bonds to ensure the credit market remained open and accessible to companies that needed to raise debt.
While those policies helped the unemployment rate fall back to below 4%, US inflation rose to levels not seen since 1982. With the US economy poised to hit records, according to estimates from JPMorgan, the Fed is shifting its focus to combat rising inflation.
This is bad news for highly valued growth stocks and other risk assets like cryptocurrencies that have seen increased volatility amid rising interest rates. Higher interest rates means a higher cost of capital that can hinder a growing company’s ability to raise cash and expand. Meanwhile, higher bond yields can offer investors a viable alternative to investing in speculative stocks, thus disrupting the “there is no alternative” bull thesis for stocks.
But with the 10-Year US Treasury rate at 1.80% Monday morning, there’s still a long way to go for bond yields to offer an attractive alternative that would lead to significant outflows out of stocks and into bonds.
For perspective, the 10-Year US Treasury yield was above 6% when the dot-com bubble began to deflate in 2000, offering investors a good safe haven to protect some of their gains from the tech boom, according to data from Koyfin.
The market rotation doesn’t mean investors with a long time horizon should head for the exits. Instead, it means a meaningful review of your portfolio is in order if it’s been especially hurt from last week’s market decline.
“Rotate yes, exit no,” BlackRock’s Russ Koesterich said of rising interest rates, adding that “a change in the rate environment does lead to changing sectors and style preferences.”
Diversification, which has been looked down upon by some meme-stock investors who like to “YOLO” on speculative stocks, is a crucial tool that can help investors weather market volatility, remain invested for the long-term, and not lose sleep at night.