Stocktake: Hawkish Fed spooks investors


A Santa Claus rally was followed by a similarly strong start to 2022, but last Wednesday reminded investors that stocks sometimes fall and fall hard. The culprit was the Federal Reserve, which signalled rate hikes may be coming sooner than expected.

Given the Fed’s growing concern over surging inflation, it’s unlikely to be unduly discomfited by short-term market volatility. The question, asked investment strategist Chris Zaccarelli, is what level of market sell-off the Fed is willing to tolerate before changing course. Is it 15 per cent? Or 20 per cent?

Zaccarelli suggests the Fed would take note if stocks suffered a recession-like fall of close to 20 per cent.

For years the Fed has been especially sensitive to market declines. Still, given recent gains – the S&P 500 surged 31 per cent in 2019, 18 per cent in 2020 and 29 per cent in 2021 – hawkish central bankers may be less inclined to heed market concerns in 2022.

Last week’s sell-off was understandable, given current valuations. The S&P 500 trades on a record price-to-sales ratio and a Cape (cyclically adjusted price earnings) ratio that has only once been exceeded – at the height of the dotcom bubble in 2000.

Stocks look reasonably priced only if one compares them to bonds, with rock-bottom yields driving the TINA (There Is No Alternative to stocks) trade.

Rising yields threaten stocks’ long-running TINA advantage. Consequently, it’s fair to assume markets will continue to obsess over Fed policy in coming months.

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