Just what is eating the US stock market in 2022?

New York — The US stock market has had a brutal run so far in 2022. 

The S&P 500, which is widely considered to be the main benchmark for the performance of US equities, dropped 13.3% through April, the steepest four-month decline to start any year since 1939. The index continues to fall in May and was down 16% so far this year at Tuesday’s close, approaching the 20% threshold that some investors consider confirmation of a bear market.

For the Nasdaq Composite, which is heavier on technology shares, the decline has been more severe — it is down about 25% so far this year.

What is weighing on equities?

The S&P 500 started the year having more than doubled from the lows it reached in March 2020, an upswing that went into reverse almost as soon as the calendar flipped to 2022.

The main factor cited by investors and analysts is the policy change at the Federal Reserve. As the pandemic took hold, the US central bank implemented emergency policies to stabilise the economy that investors say also emboldened buying of stocks and other riskier assets. But the Fed early signalled in 2022 that it was pivoting to tighter monetary policy to damp down surging inflation, a significant change to the investing environment.

Why has the Fed pivot hurt stocks?

In March the Fed raised interest rates for the first time since 2018, boosting its federal funds rate by 25 basis points. Earlier this month, it raised the benchmark by another 50 basis points — the biggest move in 22 years — and Fed chair Jerome Powell signalled similar increases could follow as it also starts unwinding assets accumulated during its fight against the pandemic’s effects.

The decisions have weighed on stocks in several ways. While equities have risen during many of the Fed’s past rate-raising cycles, some investors are concerned that surging inflation and high commodity prices could force the central bank to tighten more aggressively, potentially hurting growth and pushing the economy into a recession.

At the same time, expectations of tighter Fed policy have pushed up previously dormant bond yields. The yield on the 10-year US Treasury note has already roughly doubled this year to 3%, its first time above that level since late 2018, when the Fed was reaching the end of its last tightening cycle.

With yields rising, bonds are a more competitive investment to stocks, with the 10-year Treasury yield about twice the level of the dividend yield for the S&P 500.

Higher bond yields especially dull the allure of technology and other high-growth sectors, which are valued for their potential cash flows and lose appeal when bond yields rise. Investors say that impact has been reflected in the outsize declines notched by some post-pandemic growth bets, with the Russell 1000 growth index down 24% this year.

What else could be contributing to stock weakness?

Beyond the Fed’s change, Russia’s war in Ukraine has fuelled further economic uncertainty. For example, the turmoil has caused a supply shock that has helped drive up oil and other commodity prices, while also triggering particular concerns about Europe’s economy.

Other factors that have caused stock volatility recently include concerns about China’s economy. Lockdowns in the country to control Covid-19 have weighed on production activity there.

What signs are investors looking for to halt declines?

Investors would like to see indications that US inflation is peaking so the Fed can step back from potentially more aggressive actions. Wednesday’s consumer price index release for April is the next key report to watch.

Some investors are looking at technical indicators, such as whether the S&P 500 can hold key levels, such as 4,000 points, as well as particularly heavy days of downside volume to “wash out” the sellers, or the Chicago Board Options Exchange (CBOE) volatility index hitting certain heights. 

Reuters