20 Jan 2022
Volatility appears to be on tap as investors anticipate tightening
If the first couple weeks of 2022 are at all indicative of what’s to come this year, investors may want to buckle up; volatility has returned. With investors betting that major central banks around the globe will be in tightening mode soon, if they aren’t already, much of what worked last year – Meme stocks, crypto, large growth stocks generally, and unprofitable companies more specifically – is under fire. In fact, with real yields rising materially since mid-November, the NASDAQ just moved below its 200-day moving average for the first time since April of 2020. Might value now have its day in the sun?
Source: Board of Governors of the Federal Reserve System (US)
Inflation continues to be front-of-mind for investors, with plenty of conflicting data and divergent perspectives to be had. The headline CPI (Consumer Price Index) number for December was 7%, its highest level in four decades, with the energy component experiencing the sharpest increase on a year-over-year basis, advancing by 29% (and U.S. crude oil just hit a 7-year high this week)[1]. Food prices, which also have a material effect on most consumer pocket books, was up 6.3% year-over-year. Further, with the start of earnings season, Goldman Sachs just made headlines by announcing that its compensation expense for 2021 increased by 33%. CEO David Solomon said, “There is real wage inflation everywhere in the economy.”
Yet, the Treasury market isn’t pricing in persistently high inflation; the 5-year breakeven rate stood at 2.8% as of January 18th, down from a recent high of almost 3.2%.
Beyond a possible shift in the growth-value landscape, investors appear to be rethinking their U.S. – foreign stock weightings as well. That may be,in part, due to the notable valuation gap that has developed in recent years. According to WisdomTree’s Jeremy Schwartz, multiple expansion was a much larger component of returns to U.S. stocks over the past decade than for international developed or emerging market equities. Multiple expansion reflects sentiment, and while the revenue increases to U.S. companies was considerably higher than for their overseas peers, contributing to that positive sentiment, the valuation gap has reached a level where most strategists, Frontier included, now see substantially more opportunity abroad from a long-term return perspective.
As economist Herbert Stein famously said, “If something cannot go on forever, it will stop.” U.S. large cap growth stocks can’t always come out on top, and through the 18th of January, investors have shown a preference for both value and international, with the combination thereof faring the best. The MSCI EAFE Value Index has gained 4.7%, while the Russell 1000 Growth is off by 7.8%. Emerging market equities have also clawed their way to a small gain thus far, after being in the red last year. And as for bonds, well, it’s been a difficult start to the year, with duration taking a beating; long-term Treasuries are down by 5.9%. High quality bonds in general are off by 2.4%, and even high yield, which is far less interest rate sensitive, is off by 1.2%.
A truly new year may indeed be in store.
[1] U.S. Bureau of Labor Statistics
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| ASSET CLASS | INDEX | INDEX DESCRIPTION |
| U.S. Large Cap Growth | Russell 1000 Growth | Measures the performance of the large- cap growth segment of the US equity universe. |
| International Developed Value | MSCI EAFE Value | Captures large and mid cap securities exhibiting overall value style characteristics across Developed Markets countries around the world, excluding the US and Canada. |
| Emerging Markets | MSCI Emerging Markets | Captures large and mid cap representation across 27 Emerging Markets (EM) countries.
|
| Investment-Grade Bonds | Bloomberg US Aggregate Bond | Market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. |
| High Yield Corporates | Bloomberg US Corporate High Yield | Measures the USD-denominated, high yield, fixed-rate corporate bond market. |
| 1-3 Year Treasuries | Bloomberg US Treasury 1-3 Year | Measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury with 1-2.999 years to maturity. |
| Long-Term Treasuries | Bloomberg US Treasury 20+ Year | Measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury with 20+ years to maturity. |