Markets got off to a rocky start in the first week of 2022 with the US and Japanese markets down almost 4% over the last few days and down 2% for the week. Europe and the UK were steadier while Australia was also flat for the week after bigger daily moves. If we are looking for clues to what various scenarios might look like, last week had inflationary and maybe even stagflationary overtones (signs of slowing growth with persistent inflation). Early in the week there were rumours of a substantial stimulus by the Chinese authorities, who are likely to do ‘whatever it takes’ to avoid a debt melt-down during the upcoming winter Olympic. This was swiftly followed by the release of the minutes of the US Federal Reserve’s December meeting. When the Fed discussed the meeting, the market reacted favourably to the notion that the Fed acknowledged rising inflationary dangers and was ‘on the case’. The minutes revealed that the Fed was perhaps ready to act more quickly and more aggressively than had been assumed, and this wording may presage a full tapering of bond purchases in the next few months before actual short term interest rate rises as early as March. Then on Friday the latest US jobs report came in weaker than expected (although it is often subject to later revisions and is not yet being seen as a sign of a slowdown). Wage inflation data around the world continued to pick-up.

The overall effect of last week’s events was to put tech stocks and some of the more speculative areas of the market on the back foot (the Nasdaq was down 4%), while industrial and cyclical stocks were steady, and financials and energy rose. It also meant that what had looked like gradual rotation to value stocks from growth in December gathered pace, and over the last month global value has outperformed growth by almost 8%. Having briefly reached a market capitalisation of $3 trillion, Apple, the largest stock in the world, fell back and, along with other IT stocks, led the market down. In Australia, negative returns from most stocks and sectors were more than offset by positive returns from the major banks (which can be more profitable in a rising interest rate environment) and miners (presumably buoyed by rumours of more Chinese stimulus).  Iron ore prices were up modestly and most soft commodity and energy prices were up sharply.

The ‘real’ news was the implicit tightening of real interest rates (forgive the pun). Market implied inflation rates actually fell slightly but fixed income government bond rates edged up by more, over 5 consecutive sessions. That means widely observed nominal rates are back to pre-COVID levels in Australia and the US, although below the surface real rates remain depressed and in negative territory, especially in the US. If this process of rate ‘normalisation’ continues we could see more of the same until it starts to affect the real economy, but for now corporate credit spreads (an indicator of future corporate distress) remain resolutely tight. So the question is whether equity investors will buy the dip yet again or whether last week was the start of a longer term trend. Maybe we’ll know more next week.