High-flying session at the Stock Exchange on Monday. Prior to a last-minute recovery, major benchmarks were posting heavy losses leading them to flirt with the correction phase. The intensification of the Ukrainian crisis has added to the fear that central banks will be forced to act more quickly and more firmly than expected on interest rates in order to avoid inflationary drift. Investors weigh this eternal inflation-recession trade-off.
Very sensitive in terms of interest rates, technology stocks have dominated the general decline in stock prices since January. Already weighed down by Netflix’s results, which were below expectations, the Nasdaq index sank further into correction territory on Monday, at one point inflating its decline from its November peak to 19%. Its worst performance since the 2008 financial crisis.
Last week, the index suffered a weekly loss of 7.6%, taking the hit of a nearly 30% drop in Netflix’s share price, which had cut some 70 billion US dollars. the market capitalization of the online video service company. It had just announced a net gain of 2.5 million subscribers in the first quarter, the slowest increase for the first three months of the year since 2010, while indicating that “the growth of new subscribers was not not return to pre-pandemic levels. The platform pointed in the direction of the comeback of the pandemic while ignoring the rise of HBO Max, Disney + and Apple TV +.
A downtrend market brings the focus back to corporate profitability. The results of Microsoft, Tesla, Intel and Apple, expected this week, will add depth to the reading. The Nasdaq 100 is trading at a trailing 12-month price-to-earnings ratio of 39 times, down from 27 at the end of 2019. One can imagine the effect if earnings estimates are corrected lower.
Thus, there is first the fall in technology stocks, then the fears of a strong intervention on the key rates of a Federal Reserve having to engage in a difficult normalization of its policy and finally the geopolitical risk of a tension Russian-Ukrainian crisis pushed to the brink of American “nervous breakdowns”, deplores the European Union. All this comes as three bubbles have appeared simultaneously – in the equity, bond and real estate markets – inflated by low interest rates, the abundance of savings observed during the pandemic and the injection massive amounts of central bank liquidity.
Eyes on the Fed and the Bank of Canada
With inflation measured by the Consumer Price Index touching 7% at an annual rate in the United States, approaching 5% in Canada, the central banks in Canada and the United States will try to convince this week that they can regain control. But the speed and magnitude of the rise in key rates, and its mix with a normalization of monetary policy to be followed by a gradual offloading of bloated balance sheets with assets acquired to support the markets, is fueling investor nervousness. As a result, the S&P 500 crossed the 10% line on Monday, indicating the entry into correction territory with, at the bottom of the session, a decline of 12% since its peak on January 3. Still at the bottom of Monday’s session, the more economically sensitive Russell 2000 Index was down more than 20% from its Nov. 8 peak. Conversely, the VIX rose to 38.72 points at the session high to end at 29.90. This index, which measures the volatility of the S&P 500, generally evolves below the 30 point mark. Beyond that, it reaches a level from which the market enters territory where emotionality then takes over the rational.
In the United States, the majority of the members of the Monetary Committee of the Federal Reserve predicted at the end of 2021 three rate hikes of a quarter of a percentage point each in 2022, a similar scenario in 2023 and two hikes in 2024, this that would push the Fed’s target rate above 2%. However, the behavior of Wall Street in January and the rise in the rate of US Treasury bonds with a maturity of ten years to 1.78% project an intention attributed to the Federal Reserve to convince of its seriousness by applying a rise of 50 points of basis of its target rate at the end of its March meeting, followed by the shedding of its balance sheet starting at the end of the spring. Then other gradual increases with, as a target, a neutral rate going from 2 to 2.5%.
The dominant scenario remains that of a deceleration in inflation in the second half of the year and a cooling of wage increases, recalls Oxford Economics. But the risk of persistent inflationary growth clinging stubbornly above 3% is increasing. The strong inflationary push combines with a return to full employment to put upward pressure on wages, while supply chain distortions, amplified by Omicron, put upward pressure on prices. The emergence of a wage-price spiral could support maintaining inflation outside the central banks’ target.