Everything is Different and Nothing has Changed

Leo Wealth
by Harmen Overdijk

To start with a quote from U.S. late-night host Jimmy Fallon: “This is the Cincinnati Bengals (American football team) first Super Bowl appearance since the 1980s. A lot has changed since then. Back then, inflation was high, there was tension with Russia and our President was in his late 70s…”

 The point is that markets change but at the same time they don’t really. The sell-off in equities since the start of the year marks an overdue correction rather than the start of a bear market in our view. 

Nevertheless, January was an unwelcoming start to 2022 for financial markets. Nearly all financial assets posted negative returns. At the lowest point, the S&P 500 was down 12% from its peak, and NASDAQ was down 20%, officially entering correction territory. Higher bond yields mean a higher discount rate for future earnings, which in turn weighed down global equities. U.S. stocks were the worst performing, followed by Eurozone, and emerging market equities. UK stocks were the only ones to end the month higher.

The January correction was partially a reversal of 2021 gains, with some of last year’s hottest investment themes – such as fintech, work-from-home tech, and Cathie Wood’s innovation ETFs – hit the hardest.

 The S&P 500 had gone 61 straight weeks without experiencing a 6% drawdown – the third longest stretch over the past two decades. Stocks were ripe for a pullback. The sharp increase in bond yields provided a catalyst for the market to sell off. Stocks often suffer a period of volatility when bond yields rise suddenly, but usually bounce back as long as yields do not become restrictive to economic growth. It is important to remember that despite economic growth at above-trend levels, solid earnings growth, unemployment back at historically low levels, and a lot of extra liquidity in the global economy, bond yields and interest rates are still quite a bit lower than they were in February 2020 at the start of the pandemic.

A Bear Market?

 Historically, equity bear markets have coincided with recessions. Corrections can occur outside of recessionary periods, but for stocks to go down and stay down, corporate earnings need to fall. That almost never happens unless there is a major economic downturn. In fact, the only time in the last 50 years the broad stock market fell by more than 20% outside of a recessionary environment was in October 1987.

Despite broad-based weakness in January, we expect financial markets to regain their composure. True, global growth is slowing, but it is likely to remain very solid this year. And while bond yields will continue to rise, the pace of increase will moderate, and they will not reach constraining levels for the economy. 10-year Treasury yields could rise to 2%-to-2.25% by the end of the year, which is well below the level that would likely trigger a recession. Thus, investors should stay overweight stocks relative to bonds over a 12-month horizon.

Historically, equities struggle two-to-three months before the first rate hike. January and now February volatility and pullbacks are textbook behavior of equity markets dealing with a change in direction of monetary policy. We should keep in mind that in three of the four tightening cycles since 1990, the stock market was higher 12 months later.

Going forward, robust economic growth will support equities. U.S. GDP expanded by 6.9% annualized in 4Q 2021. While economic growth will slow this year, strong demand from households and businesses will ultimately keep GDP expanding at an above-trend pace. This should be positive for corporate earnings and therefore equity prices. So far 79% of the S&P 500 companies that have reported 4Q 2021 earnings have delivered a positive earnings surprise.

Forward price/earnings multiples of the S&P 500 have come down from 21.7x to a more reasonable 19.5x. International stocks are trading at lower multiples than those in the U.S. In our view, equity markets are not expensive at the moment given solid economic growth and still low interest rates.

Inflation and Why the Fed Could Turn Dovish

Gradually, we learn to live with COVID, and spending on services bounces back. The pandemic did trigger some permanent changes to our lifestyles, for example, hybrid office/home working and more online shopping.

In the past two years, the economy has been driven by a huge increase in spending on goods. Now that the world is opening up again, spending on services like travel and hospitality will increase. In contrast, spending on goods is currently slowing. The simple reason is that durables, by their very definition, are durable. Even nondurables such as clothes and shoes are in fact quite durable. “Durable” means that there are only so many cars, iPads, clothes, and shoes that any person can buy before reaching saturation.

In the fourth quarter of 2021, U.S. consumer spending dipped to below its pre-pandemic trend. The question is whether spending on services will make up for the slowing demand for goods. If spending on services fails to catch up to its pre-pandemic trend while spending on goods falls back to its pre-pandemic trend, then there will be a demand shortfall.

The good news is that durable goods spending is leading inflation. In fact, the U.S. core inflation rate has already been declining for five consecutive months. With spending on goods now slowing down, inflation will likely also come down later this year as the sharp rise last year was mostly driven by supply chain bottlenecks due to the rise in demand for goods. Therefore, we still think this inflation spike is transitory. We think consumer price inflation could fall back below 3% in the coming months. This can have an impact on the Fed’s, and other major central banks’, monetary policy.

The Futures market is now pricing in seven rates hikes between now and March 2023. Our sense is that the Fed’s tone will become more dovish again when the inflation numbers soften and economic growth continues to trend down. That would be a positive ‘surprise’ for the economy and risk assets.


Despite the dollar’s strong performance, commodities, led by oil, generated positive returns in January. This highlights that fundamentals of tight supply and demand dynamics are dominating the trajectory of commodity prices. Heightened geopolitical tensions are likely also contributing to both dollar strength as well as higher energy prices.

We think commodities are an important component of a diversified balanced portfolio at the moment. The commodity cycle offers diversification to both geopolitical and inflationary risks.


A Russian invasion of Ukraine is a possible event that attracts a lot of attention and adds to current market uncertainty. Any military action could have an impact on short-term market sentiment but the scale of the impact will depend on how such a conflict unfolds.

We think Russia’s real objective is to destabilize Ukraine’s current government and they might be able to achieve that without taking any military action. Ukraine’s President Zelensky already called for Biden to tone down his ‘war talk’ as it is hurting Ukraine’s economy. This is understandable – who would invest in the Ukraine or even buy anything from there while the U.S. and EU are telling everyone to prepare for war. Even if Russia does invade Ukraine, we do not think that it will have a lasting impact on global financial markets. However, a short-term market sell-off is a possibility.

Eurozone Headline Inflation At New Record High In January 

Eurozone inflation surprised to the upside in January. The headline estimate accelerated to a fresh record high of 5.1%. Notably, both food and energy inflation accelerated in January. Meanwhile, core inflation – which strips out these two categories – eased from 2.6% year-on-year to 2.3%. In fact, core inflation was -0.8% on a month-on-month basis, which suggests that underlying inflationary pressures may already be easing.

The behavior of financial assets after the inflation number release suggests that the market expects inflation to pressure the ECB to move in a more hawkish direction as well, which caused German Bund yields and the EUR/USD to rise. The ECB may raise its inflation outlook when it releases its new set of macroeconomic projections in March. However, the ECB is likely to maintain its cautious approach to normalizing monetary policy and probably will not hike interest rates in 2022.


Among emerging markets, China’s debt burden is especially pronounced. Total private and public debt reached 285% of GDP in 2021, nearly double what it was in early 2008. The property market is also slowing, which will weigh on growth.

China finds itself in a paradoxical situation: Any effort to pare back debt is likely to hurt nominal GDP by so much that the debt-to-GDP ratio rises rather than falls. Ironically, the only solution is to adopt reflationary policies that allow the economy to run hot. Especially in 2022, the Chinese government will want to show that it can sustain economic growth despite its zero-covid policy.

In the near term, this could prove to be a positive outcome for investors since it will mean that monetary policy stays highly accommodative. Over the long haul, however, it may lead to a stagflationary environment, which would be detrimental to equities and other risk assets.

Fixed Income

Relatively, the biggest sell-off in January happened in the bond market. The Bloomberg Global Aggregate Bond Index is down almost 2.5% since the start of the year. In an environment where the U.S. 10Y Treasury yield is at 1.9%, it will be difficult to achieve a positive return on a core investment grade fixed income portfolio.

The only part of the fixed income space where we think returns will be positive is in high yield markets. We prefer short-dated corporate high yield, either listed or private credit, and higher-yielding emerging market government bonds.


This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.

Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value.

The Nasdaq Composite Index is a market-capitalization weighted index of the more than 3,000 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depositary receipts, common stocks, real estate investment trusts (REITs) and tracking stocks. The index includes all Nasdaq listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds (ETFs) or debentures.

The Bloomberg Barclays US Aggregate Bond Index, or the Agg, is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. Investors frequently use the index as a stand-in for measuring the performance of the US bond market.

Investments in emerging markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.

Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.

Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.

Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

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