Investment Strategy Commentary: Market Pullback

Our outlook for 2022 was focused on the transitions the economy and markets were facing — including fading fiscal stimulus, reversal of monetary accommodation and a maturation of the COVID pandemic. Our constructive outlook on risk taking was, and remains, based on a constructive outlook for corporate earnings and interest rates.

The recent sell-off has put us into another 5% correction — something that has historically happened every 10 weeks (see Exhibit 1). Today markets almost closed in 10% correction territory — something that has historically happened every 34 weeks, and of which we are well overdue (current stretch is 94 weeks). Weakness can be attributed to a combination of concerns about rate hikes, economic growth and corporate earnings. There is also the unquantifiable risk surrounding Russia’s intentions toward Ukraine.

The concern about interest rates seems overblown. Market expectations for the Fed funds rate at the December 2022 meeting have only increased by 25 basis points over the last month and the 10-year Treasury yield is right in the middle of our 1.5%—2.0% forecasted range.1 We think the Fed will manage its balance sheet with a strong aversion to inverting the yield curve. Moreover, some further upward move in long-rates, if driven by the real component versus inflation, is unlikely to spell the end of the bull market or expansion.

We think concerns about economic growth are inflated. Omicron is peaking in key parts of the U.S., so the weakness in high frequency data should start to reverse. Consumers have $2 trillion of excess savings, and corporate inventories are near historic lows — both of which should underpin growth. The start of earnings season has seen some high profile companies warn about their outlooks (banks on costs, pandemic winners on future demand). We don’t yet think these are valid read-throughs to the broad markets, and don’t expect material negative revisions. We think the strong demand outlook should help offset cost pressures from areas like wages.