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Last week saw U.S. equities endure their second-worst start to a year since the Lehman Brothers collapse, driven by further hawkishness from the Federal Reserve and a sell-off for highly valued U.S. tech stocks. The trend continued on Monday, as global stocks slid into the red once again.
A key source of the hawkish surprise offered by the Federal Open Market Committee’s latest meeting minutes was policymakers’ desire to tighten its balance sheet, the significance of which Deutsche Bank analysts have argued was vastly underappreciated by the market previously.
The rapid spread of the omicron Covid-19 variant around the world has also been a persistent cloud over the equity outlook in recent months, with daily caseloads reaching record numbers and tighter social restrictions in many major economies.
“The Omicron Covid variant may have led to more restrictions but the economic recovery remains resilient nevertheless, which means stocks don’t appear particularly vulnerable to a correction,” Luca Paolini, chief strategist at Pictet Asset Management, said Monday.
Paolini suggested that the global economic recovery remains supported by a strong labor market, pent-up service demand and healthy corporate balance sheets. As a result, Pictet is looking for opportunities to increase its weighting in stocks in 2022.
However, he acknowledged that despite strong GDP growth expectations, particularly in the U.S. and Europe, surging inflation does pose some downside risk — and will likely peak in the first half of 2022 along with prompting the Fed to hike interest rates by June.
Although Pictet holds a positive outlook for equities, Paolini’s team has taken a tactically neutral stance on the asset class as a whole in light of liquidity conditions for the U.S. turning negative and stocks continuing to be highly valued.
James Solloway, chief market strategist at SEI’s Investment Management Unit, struck a similar tone last week, noting that GDP growth will decelerate, labor markets will tighten, inflation will peak and Covid will continue to have a short-term negative effect, the global economy should continue to manage through the periodic setbacks.
“Although there have been pockets of speculative behavior in some areas of the financial world — meme stocks, SPACs, cryptocurrencies and NFTs, for example — we do not see the sort of speculative fervor that would point to a serious equity correction in 2022,” Solloway said.
Although the data so far has indicated that the highly transmissible omicron variant may not be as severe as previous iterations of the virus, Mazars Chief Economist George Lagarias said Thursday that markets should avoid complacency about the possibility of other pandemic-related shocks.
“We can’t allow ourselves to fall into the trap of trying to predict the timeline for an endgame when the next turn is unknown. Currently, risk is non-linear, but parabolic,” Lagarias said.
“All it takes is one new vaccine-resistant dominant variant to undo months of global vaccination and throw predictions out of the window.”
U.S. valuation vulnerability
Lagarias also highlighted that U.S. stocks, in particular, are expensive and concentrated — a feature highlighted during last week’s weakness among tech behemoths — but noted that investors have few alternatives to stocks in general at present.
He suggested that a correction in risk asset prices is increasingly possible due to the paradigm shift from central banks on quantitative easing, while inflation is here poses a continual dilemma.
“All that uncertainty is bad for business, but how risk assets are going to do is still unknown, as the drivers have been for too long completely decoupled from all of the above,” Lagarias said.
“It could be that the ‘residual liquidity’ and ‘there is no alternative to stocks’ arguments prevail, or it could be that markets go into ‘fear mode’ and secular volatility rises.”
Kristina Hooper, global market strategist at Invesco, included a potential U.S. stock market correction in her top 10 predictions for 2022.
“There is likely to be a US stock market correction in the first half of 2022, but I expect a relatively swift recovery,” Hooper said.
“It’s been so long since we have had a sizeable correction that the odds of one have grown — and increasing the odds is the fact that the Federal Reserve is starting to normalize monetary policy in the first half of 2022 and may start to hike rates.”
Original news source Credit: www.cnbc.com