Bassanese Bites: Correction or recession? – January 31 2022

Global markets

It’s nice to be back from holiday.. what did I miss? One of the downsides of being a market analyst is that it’s often hard to switch off from markets even when on a break, especially when volatility spikes and there are big market-moving events. The past few weeks are a case in point!

All that said, what we’ve seen to date is largely what I’ve been fearing since the Powell pivot in early December, when the U.S. Fed chair dropped reference to inflation being “transitory”. This confirmed expectations that the Fed would raise rates this year, which in turn meant bond yields would likely move higher – which in turn would put downward pressure on still lofty U.S. PE valuations. What’s perhaps most surprising is the speed of the market correction, with the S&P 500 down 9.8% from its recent 3 January peak at the low last Thursday. What’s less surprising is that the more interest-rate sensitive growth/technology sectors (and so the U.S. market) have been hit hardest, with value/defensive areas holding up better.

So where are we today? U.S. 10-year bond yields have leapt from around 1.5% to almost 1.8% since late last year. I still think they will break above 2% in H1 this year. The S&P 500 forward PE ratio has declined from 21.7 to a (still lofty) 20.3, which suggests some caution in thinking the bottom for the market is already in. The good news so far is that corporate earnings remain robust – indeed, what turns a mid-cycle valuation-driven market correction (of 10 to 20%) into an ugly bear market (20 to 50% decline) is when earnings also collapse, which in turn would require a U.S. recession.

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