February 2022

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Monthly Market Summary

• The S&P 500 Index produced a -5.3% total return during January, outperforming the Russell 2000 Index’s -9.5% total return
  
• Energy was the only sector to trade higher, returning +18.8% as oil prices soared +17.4%. Financials were the second-best sector, returning +0.0% as interest rates rose. Consumer Discretionary was the worst-performing sector with a -9.5% return, followed by Real Estate’s -8.6% return and Health Care’s -6.9% return.
• Corporate investment grade bonds generated a -3.6% total return and underperformed corporate high yield bonds’ -2.7% total return.
• The MSCI EAFE Index of global developed market stocks returned -3.6% during January, underperforming the MSCI Emerging Market Index’s +0.0% return.

Surging Inflation

The Federal Reserve is moving closer to addressing high inflation. The U.S. central bank is preparing to tighten monetary policy by ending its monthly bond purchases and raising interest rates. Monthly asset purchases were initiated during the pandemic as a way to inject money into the economy by buying bonds, allowing lenders to go back out and lend again. In addition, interest rates were lowered to decrease financing and debt servicing costs. Together, bond purchases and low interest rates stimulated demand during the depths of the pandemic. However, the two monetary policies appear to have done too good of a job stimulating demand. Inflation rose +7% year-over-year during 2021, the fastest pace since 1982. Now, the Federal Reserve is preparing to reverse the two policies and tighten financial conditions to dampen strong demand.

Interest rates rose during January in anticipation of the Federal Reserve’s actions. The 10-year Treasury yield rose +0.27% to end the month at 1.78%, back near January 2020 levels. Rising interest rates led to higher real yields, which is the yield an investor earns after accounting for inflation. Figure 1 on page 2 shows real yields rose during January 2022 after touching a record low in 2021 due to a combination of high inflation and near-zero interest rates. 2021’s deeply negative real yields caused investors to turn to riskier investments to generate positive after-inflation returns.
 

Tighter Financial Conditions & Treacherous Market Volatility

There was a broad rotation in the equity and credit markets during January. De-risking was a prominent theme as real yields rose and investors adjusted portfolios. The S&P 500 and Russell 2000 indices both traded lower, and all but one of the eleven S&P 500 sectors traded lower. Trading action was volatile at times with large intra-day reversals. The S&P 500 swung more than 2% between the intra-day high and intra-day low each day from January 20th-28th, with a 4.6% intra-day swing on January 24th. The increased volatility is being attributed to changing Federal Reserve policy.

There were multiple performance trends worth mentioning. Figure 2 below shows S&P 500 Growth underperformed S&P 500 Value by -6.7% during January, Growth’s fourth biggest month of underperformance since January 1994. Growth stocks are valued based on their future earnings, and rising interest rates tend to decrease the price-to- earnings multiple markets place on those earnings. In the credit markets, bonds generated negative returns and did not offer protection from the equity market selloff. Finally, cryptocurrencies plunged during January, with bitcoin falling -19.4% as speculative assets saw aggressive selling.

2022 is off to a difficult start, but it is important to keep the big picture in mind. Figure 3 graphs the S&P 500’s price return and maximum pullback for each year since 1986. The chart shows the S&P 500 experienced an average maximum pullback of -14.2% since 1986. For comparison, 2021’s maximum pullback was -5.2%, or almost 10% below the average. The data indicates 2021 was the exception, not the rule. Volatility is the price of admission to investing and will continue to impact portfolios. Experiencing market selloffs is unpleasant, but Figure 3 shows annual returns historically finish the year above the maximum drawdown level.

IMPORTANT DISCLOSURES

Clare Market Investments, LLC is a Registered Investment Advisor. This material is for informational purposes only. It is not intended as and should not be used to provide investment advice and is not an offer to sell a security or a recommendation to buy a security. This summary is based exclusively on an analysis of general market conditions and does not speak to the suitability of any specific proposed securities transaction or investment strategy. Judgement or recommendations found in this report may differ materially from what may be presented in a long-term investment plan and are subject to change at any time. This report’s authors will not advise you as to any changes in figures or views found in this report. Investors should consult with their investment advisor to determine the appropriate investment strategy and investment vehicle. Investment decisions should be made based on the investor’s specific financial needs and objectives, goals, time horizon and risk tolerance. Except for the historical information contained in this report, certain matters are forward-looking statements or projections that are dependent upon risks and uncertainties, including but not limited to such factors and considerations such as general market volatility, global economic risk, geopolitical risk, currency risk and other country-specific factors, fiscal and monetary policy, the level of interest rates, security-specific risks, and historical market segment or sector performance relationships as they relate to the business and economic cycle. See claremarket.com for additional information and disclosures. © 2021 Clare Market Investments, LLC

“The market is a pendulum that forever swings between unsustainable optimism and unjustified pessimism. The Intelligent Investor is a realist who sells to optimists and buys from pessimists.”

- Jason Zweig