Making sense of tumultuous markets
Morgan Stanley Wealth Management05/11/22
Summary: Wild swings in US stocks have left investors whiplashed and wondering what’s next. Three factors may be at play.
Stock market volatility was on full display last week. Equities rose sharply immediately following the Federal Reserve’s May 4 meeting, where the central bank announced a widely expected half-percentage-point hike in interest rates and dismissed the idea of a 0.75 percentage point hike in the future. Just the next day, however, US stocks nosedived.
Some broader context: Heading into the Fed’s May meeting, April’s hefty losses had made valuations of many stocks—including coveted mega-cap tech names—more attractive, and market indicators were also suggesting “oversold” conditions. So, it isn’t altogether surprising that stocks staged a brief, midweek “relief rally,” as investors appeared to “buy the dip”. However, as the rest of the week demonstrated, markets remain volatile.
For investors looking to make sense of recent market activity, Morgan Stanley’s Global Investment Committee (GIC) breaks down three potential factors:
1. The move toward tighter US monetary policy is accelerating.
Rate hikes are just getting started, with a doubling in magnitude for the first two. What’s more, the Fed is now set to start shrinking its balance sheet. Financial conditions have tightened, and current market expectations show that rates are likely to rise by another 2 percentage points by year-end. As Fed Chair Jerome Powell acknowledged last week, a “soft landing” for the economy is not guaranteed. In fact, 11 of the 14 Fed tightening cycles since 1950 have resulted in recession.
2. The corporate profit outlook is dimming.
While first-quarter earnings were generally better than expected, these results are backward-looking and don’t reflect the full impact of tightening policy and slowing growth. Looking ahead, corporate profits face a number of headwinds, including:
- pressure from rising costs,
- a normalization of demand from the early days of the pandemic,
- weaker international demand, and
- the strongest dollar in decades, which can hurt US exports and the translation of overseas profits by US companies.
Likely reflecting these challenges, a growing share of companies are now lowering their expectations for future performance.
3. Geopolitical uncertainty remains high.
Events outside the US continue to affect trade, supply chains, and commodities. With no resolution to the Russia-Ukraine conflict in sight, for example, Europe is now poised to ratchet up energy-related sanctions that may sustain inflationary pressures for the foreseeable future. This creates uncertainty for central banks, feeds volatility in currencies, produces headwinds to COVID recoveries, and raises the pressure on emerging market countries already struggling with high costs.
With uncertainty high, consider exploring funds that are actively managed to outperform market benchmarks—while striving for diversification. Treasuries, which the GIC believes are trading closer to fair value, may provide a way to temper stock market volatility.
Keep in mind, periods of volatility are not uncommon and should be taken in stride. Most importantly, stay disciplined, and make sure portfolios remain aligned to individual goals, timelines, and risk tolerance.
Morgan Stanley disclosures
Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision.
Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.
Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.
Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.
Rebalancing does not protect against a loss in declining financial markets. There may be a potential tax implication with a rebalancing strategy. Investors should consult with their tax advisor before implementing such a strategy.
Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile.
International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.
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