At the beginning of this year, Marko Kolanovic and John Stoltzfus – the two most optimistic voices on Wall Street – were convinced of one thing: the Federal Reserve (Fed) would implement its plan to raise rates, but at a very, very slow pace. Even if inflation rises, that’s not a bad thing. And according to them, interest rates will rise so slowly that the financial markets will barely notice.
Kolanovic, head of research at JPMorgan Chase, predicts the market will continue to post another year of broad gains, with the S&P 500 index reaching 5,050 by the end of 2022. Stoltzfus, Oppenheimer’s director of investment strategy, was even more optimistic. giving a mark of 5,330 points.
In the end, the predictions were all wrong, differing more than 1,000 points from what happened.
These two figures – two senior leaders at two big names on Wall Street – are a good example of what has happened over the past year. With few exceptions, most experts in both the stock and bond markets could not have imagined that inflation would change the investment world so dramatically. The Fed acted too fast, too hard, sending both stocks and bonds to their worst year since the 1970s.
There are currently 865 mutual funds that actively invest in stocks and have assets of at least $1 billion. On average, they lost 19% in 2022. Equity hedge funds also lost heavily. In the bond market, 200 funds with assets of $1 billion or more also lost an average of 12%. Most perform much worse than benchmarks.
To be honest, it is not difficult for anyone to accurately predict what the market will look like this way. A series of unexpected shocks to the world economy caused earthquakes in the markets. For example, no one thinks that China will stick to its Zero Covid policy until the end of the year or that Russia will carry out a special military operation in Ukraine.
According to Ken Leech, CIO of investment fund Western Asset Management, 2022 is a very challenging year. Recently, however, the performance of the Core Plus Bond Fund that Leech manages has begun to improve, growing 3.6% in the fourth quarter. “We have adjusted our entire portfolio to changes in the macroeconomic environment and believe the fund is well positioned to benefit from the global economic recovery,” he said.
The Fed’s rate hikes were one of the biggest drivers of the market’s collapse. For a long time, the market has believed that policymakers are always there and ready to bail out when the situation worsens, scaling back plans to raise or even lower rates. Therefore, a falling market is a good time to hit the bottom.
This thinking was born just after the last time America faced inflation. By the mid-1980s, once prices had stabilized, the Fed could easily concentrate fully on its mission to support economic growth and jobs. In the process, they also inadvertently “inflated” both stocks and bonds.
But now that confidence has been shattered in the current era of high inflation. Instead, the “Fed pivot” causes negative effects on the market. Investors used to expect that the Fed would have to stop raising rates, even cutting rates, to prevent the US economy from sliding into recession. But confidence was again shattered when Fed Chairman Jerome Powell repeatedly affirmed that interest rates would continue to rise until inflation was fully under control.
The market is on fire because of the Fed
The Fed has made many mistakes. Throughout 2020 and 2021, Mr. Powell convinced that inflation is temporary. Prices are rising due to bottlenecks in the supply chain and trillions of dollars are being pumped in to boost growth, which will quickly cool inflation.
These comments bolster investor confidence that the era of super-low interest rates is still upon us. Last June, they were still betting that inflation would fall to around 3% over the next 12 months. That is, by the end of 2022, the Fed will only raise rates by about 0.4%.
That was a fatal mistake. Inflation has even reached 9% and interest rates have risen by more than 4%.
Not just the underestimated inflation, many in the private community still believe that the Fed will save everything. The irony is that professional investors on Wall Street once mocked the “ignorants” who were “burnt out” by frantically chasing GameStop stock or the Shiba Inu digital currency. But ultimately they are no different if the so-called elites of the financial world blindly believe that thanks to the Fed, the market only goes up, never down.
“If you’re rich and famous by the end of 2020, it’s because interest rates are super low. All your success comes from low interest rates,” said Andrew Beer, an expert on the Dynamic Beta ETF. Dynamic Beta is up 21% year-to-date on bets against bonds.
Therefore, Beer believes it is time for investors to rethink their approach. Rising interest rates and the way investors are being forced to lower their forecasts for future corporate earnings are particularly negative for technology stocks.
There are some signs that Wall Street is changing, albeit slowly.
In early December, when many institutions released their 2023 forecasts, something surfaced that hadn’t happened since at least 1999: Many experts agreed that the S&P 500 will have a down year.
Among those who have lowered their forecast for 2023 is Drew Pettit, a 33-year-old strategist at Citigroup. He is well aware that the “everything goes up” view is extremely dangerous. Once predicting the S&P 500 would finish above 5,000 by 2022, Pettit now estimates it at 4,000 for 2023. “There will be a lot of ups and downs in the coming year that we have to get through,” he said.