A painful start to 2022

As central banks harden their stance on inflation, financial markets are experiencing short-term upheaval. But if economies remain strong, stocks should soon bounce back. 

Wall street sign

Some of the world’s biggest stock markets, notably the US S&P 500, had their worst start to the year since the financial crisis amid growing investor concerns about more interest rate rises than they’d expected, the squeeze on consumer incomes from inflation and the geopolitical risks posed by the Russia-Ukraine stand-off.

Going into February, stock markets had begun tentative, but short-lived, rallies. We’re braced for further volatility, but we think a market rebound is likely in the first half of this year.

As our co-chief investment officer Ed Smith explains in this video update, corrections of the magnitude we saw in January are normal. They occur in more years than they don’t, and rarely prevent equity markets from delivering positive calendar-year returns. Bear markets are rare without an economic recession, and there’s little risk of one this year.

A broad swathe of forward-looking economic indicators suggests that the US and global economies are still expanding solidly. Our analysis of some of our favoured survey-based indicators of business, construction and consumer confidence indicate there’s a less than 3% chance of the US falling into recession in the next three months. Looking at the world from the ‘bottom up’ – by way of company earnings – also suggests a recession looks unlikely. Company results for the fourth quarter earnings season are, so far, fairly upbeat (with some notable exceptions). Nearly half of S&P 500 companies have reported their fourth-quarter earnings and more than 75% have beaten consensus earnings expectations. In aggregate, these companies are reporting year-on-year earnings growth of above 25%.

With company earnings still rising, equity market declines have been driven by falling valuations, partly because investors are demanding more compensation for uncertainty around tomorrow’s earnings as they position themselves for a world in which some of the biggest central banks are hardening their efforts to combat inflation.  

The US Federal Reserve (Fed) has now opened the door to a rapid cycle of interest rate rises, while the Bank of England (BoE) has increased rates twice in successive months. This policy tightening is driving up government bond yields, and unnerving some stock investors as these yields are used to calculate the value of stocks’ earnings tomorrow in today’s prices. But rising bond yields are not ordinarily a headwind to stock markets overall, especially when this rise is due to a decent economic outlook, which is especially the case now that Omicron seems to be waning.

Inflation pressures have definitely broadened out in recent months. But we continue to expect global inflation to fade meaningfully from the spring as energy prices start to ease and spending patterns normalise. (You can find out more about our inflation outlook in our year-end InvestmentUpdate and related videos.)

Rotation in motion

It makes sense that markets are experiencing upheaval as they adjust to the prospect of tighter central bank monetary policy and higher borrowing costs. Companies that are focused on growing rapidly to create a large and (hopefully) profitable dominance many years into the future have been hit hardest. Many of these more speculative businesses have been fed with cheap money, so as the era of cheap money passes, they are likely to struggle. This has spilled over somewhat into other ‘growth’ companies that are profitable today, but have high prices relative to earnings, as investors have  been more interested in buying ‘value’ businesses that are priced more cheaply.. The leaders of this value  rally are banks, which can make more money from higher borrowing costs, and the energy companies that are enjoying a ramp-up in the price of what they sell. The rotation from growth and into value intensified sharply in January, leading to a year-to-date decline in the growth-heavy Nasdaq Composite index of about 10% at the time of writing.

We believe businesses that can reliably increase their profits faster than GDP growth should rebound well once the ‘cyclical’ gains of the pandemic reopening are behind us and investors once again crave quality, dependable earnings growth.

Meanwhile, we believe that companies whose earnings are driven partly by structural themes – such as cloud computing, green buildings and construction, or digital health and wellbeing – also warrant closer attention when easy cyclical gains are behind us. As innovations and disruption broaden out into other sectors from the giant technology platforms that have dominated returns over the last five years, we expect ‘micro’ themes to play a greater role in driving these returns. We will be talking to you about these themes more throughout the year.


Important legal information

This area of the site is for professional advisers

Please read this page before proceeding, it explains certain legal and regulatory restrictions applicable to the distribution of this information. It is your responsibility to inform yourselves of and to observe all applicable laws and regulations of the relevant jurisdiction.

This section of the website is directed only at investment advisers and other financial intermediaries who are authorised and regulated by the Financial Conduct Authority (FCA).

The information provided in this site is directed at UK investment advisers only and must not be circulated to private clients or to the general public. It does not constitute an offer to sell, or solicit an offer to purchase any investments by anyone in any jurisdiction in which such offer or solicitation is not authorised or in which a member of the Rathbone Group is not authorised to do so.

I confirm that I am an investment intermediary authorised and regulated by the Financial Conduct Authority. I have read and understood the legal information and risk warnings below:

Important Information (Terms and Conditions)

The information contained on this site is believed to be accurate at the date of publication but no warranty of accuracy is given and the information is subject to change without notice. Any opinions or estimates included herein constitute a judgement as of the date of publication and are subject to change without notice. Furthermore, no responsibility is accepted for the accuracy of any information contained within sites provided by third parties that may have links to or from our pages.

Rathbone Investment Management Limited ("RIM") is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered Office: Port of Liverpool Building, Pier Head, Liverpool L3 1NW. Registered in England No 01448919.

In accordance with regulations, all electronic communications and telephone calls between Rathbones and its clients are recorded and stored for a minimum period of six months.

The information provided in this site is directed at UK investors only. It does not constitute an offer to sell, or solicit an offer to purchase any investments by anyone in any jurisdiction in which such offer or solicitation is not authorised or in which a member of the Rathbone Group is not authorised to do so.

In particular, the information herein is not for distribution and does not constitute an offer to sell or the solicitation of any offer to buy any securities in France and the United States of America to or for the benefit of United States persons (being resident in the United States of America or partnerships or corporations organised under the laws of the United States of America or any state, territory or possession thereof).

In order to comply with money laundering and other regulations, additional documentation for identification purposes may be required.

Rathbones shall have no liability for any data transmission errors such as data loss, damage or alteration of any kind including, but not limited to, any direct, indirect or consequential damage arising out of the use of services provided or referred to in this website.

Past performance should not be seen as an indication of future performance.

The value of investments and the income from them can fall as well as rise and you may not get back the amount originally invested, particularly if your client does not continue with the investment over the longer term.

Changes in the rate of exchange between currencies may cause the value of an investment to go up or down.

Interest rate fluctuations are likely to affect the capital value of investments within bond funds. When long term interest rates rise the capital value of units is likely to fall and vice versa. The effect will be more apparent on funds that invest significantly in long dated securities. The value of capital and income will fluctuate as interest rates and credit ratings of the issuing companies change.

Tax levels and reliefs are those currently applicable and may change and the value of any tax advantage will depend on individual circumstances.

Investing in emerging markets or small companies may be potentially volatile, as these investments are high risk.

The design, text and images are owned, except as expressly stated by members of the Rathbone Group. They may not be copied, transmitted, displayed, performed, distributed, licensed, altered, framed, stored or otherwise used in whole or in part or in any manner without the written consent of Rathbones except to the extent permitted and under the procedures specified in the copyright Designs and Patents Act 1988, as amended and then only with notices of Rathbones' rights.

Subscribe to the In the KNOW blog email