Schwab’s Quick Take on Stock Market Volatility

The stock market in the United States lost another day on Monday as investors weighed the possibility that the Federal Reserve’s vigorous anti-inflation drive would force the country into recession. Except for the more defensive Consumer Staples sector, no industrial sectors were spared, with Technology, Consumer Discretionary, and Energy being among the hardest hit. Bitcoin fell roughly 12% during the day as a result of the pressure. Since its all-time high in November, the cryptocurrency has lost half of its value.

Investors are growing anxious that the Fed will struggle to combat historically high inflation without stifling economic development. In our opinion, the Fed will raise its benchmark interest rate in half-percentage-point increments over the next four sessions before easing back to zero. Later this year, there will be a quarter-point increase. According to current predictions, the Fed wants to raise rates to a “neutral” level by the end of the year, which might be about 2.5 percent.

Markets expect the rate to rise to 2.6 percent by the end of the year, then to 3.2 percent by next July. Separately, the Federal Reserve Bank of New York released a survey on Monday showing that respondents’ three-year inflation forecasts increased to 3.9 percent in April. Rising prices might create a self-fulfilling prophecy if households push forward purchases because they believe prices will continue to rise, confounding the Fed’s efforts.

“Stock prices already reflect some economic weakness, but they haven’t factored in the probability of a recession,” says Schwab’s chief financial strategist, Liz Ann Sonders. “

“Equities could fall significantly lower if GDP continues to deteriorate.”

“In the short run, investors are unlikely to find much return in risk-taking, and should instead focus on quality,” she adds. “One method to take advantage of volatility while keeping your strategic allocation is to rebalance your portfolio on a regular basis.”

Volatility in US stocks is likely to continue

  • As the Fed raises interest rates, stocks are expected to stay volatile.
  • Since the last Fed meeting, the benchmark S&P 500® Index has dropped more than 7%, making it one of the worst post-meeting periods in history. Large-cap technology and growth-oriented firms have continued to struggle, wreaking havoc on market cap-weighted indexes.
  • The NASDAQ and Russell 2000, both centred on technology, are in bear markets. For the time being, the S&P 500 remains in a state of severe correction.
  • The danger of a recession is strong, and sector volatility is expected to remain high. We continue to advocate for a sector-neutral strategy that emphasises high-quality factors including robust balance sheets, high free cash flow yields, and positive forward earnings revisions.

Stocks around the world are less volatile.

  • China’s “zero-COVID” policy has resulted in massive lockdowns, which are dragging on global GDP. However, as more Chinese cities move to frequent testing, shorter, targeted lockdowns may become the norm in the coming months.
  • As the EU’s attempt to ban Russian oil faltered, and Saudi Arabia dropped prices owing to lower global demand, energy prices fell. Markets appear increasingly concerned about economic growth, despite the possibility of inflation peaking.
  • We believe that equities with shorter durations—those with greater current cash flows rather than future cash flows—can nonetheless outperform in the intermediate run. Investors aren’t using fundamentals to make judgments, as seen by widespread decreases across countries and sectors.

Bonds: Concerns about inflation continue to boost yields.

  • Despite Fed officials’ statements that rate hikes will likely be gradual, the Fed funds futures market is signalling a slower pace of hikes now that the collapse in risk assets is tightening financial conditions on its own. Treasury yields have dropped.
  • Treasury rates from three to thirty years are settling in between 2.75 and 3.25 percent, well above the Fed’s “neutral” prediction. Historically, during a rate hike cycle, Treasury yields converge near the neutral rate, signalling that Treasury yields are unlikely to rise much further.
  • We recommend that investors concentrate their efforts on higher-quality bonds, such as Treasuries and investment-grade municipal and corporate bonds, because riskier sectors of the market often do poorly during tightening cycles. High-yield bonds should be approached with caution by investors.
  • As the Fed raises rates, short-term borrowing costs may rise. Short-term interest rates are frequently related to home equity loans, adjustable-rate mortgages (ARMs), and vehicle loans.

Takeaways for traders: Volatility is expected to persist.

  • The S&P 500 fell to a fresh 13-month low after breaking below technical support around 4,050. The NASDAQ has dropped to a fresh 18-month low and is still in bear market territory.
  • Volatility is still high. The Cboe Volatility Index, or VIX, surged above 35 for the second day in a row during the day, but closed slightly lower at 34.70. The VIX currently implies daily swings of 72 points in each direction in the S&P 500 index. In each of the last four sessions, though, it has advanced further.
  • Option premiums are historically high, making downside risk protection very expensive, given current volatility predictions. Traders could consider using multi-leg techniques to offset hedging costs, such as vertical spreads or collars
  • Equity traders should think about lowering their typical deal size and money amount. While strong bounces in equities are possible at any time, significant downward swings are also possible. Margin maintenance calls become more likely when stocks have dropped more than 10%.

What are the options for long-term investors now?

  • Market volatility is unnerving, but it has happened before. If you’ve established a well-diversified portfolio that suits your time horizon and risk tolerance, the recent market decline will most likely be a minor blip in your long-term investment strategy.
  • When markets are volatile, though, it can be difficult to do nothing. Take a look at some of our investment principles in light of recent events:
  • Make no attempt to time the markets. It’s almost unthinkable. What matters in the market is time. While maintaining the course and investing even when markets are down might be stressful, it is better for your portfolio and can result in more acquired wealth over time.
  • Create a diversified portfolio based on your risk tolerance. It’s crucial to understand your tolerance for momentary losses. A market collapse can sometimes act as a wake-up call that you aren’t as comfortable with losses as you thought you were, or that a portfolio you believed was properly diversified isn’t. isn’t the case. Clients of Charles Schwab can log in and use the Schwab Portfolio Checkup tool to see if their portfolio is still in line with their target asset allocation. Our investor profile questionnaire will help you assess your profile and connect it to a suitable target asset allocation if you’re not a client or haven’t yet formed an investment plan.
  • Regularly rebalance your portfolio. Market fluctuations may cause your allocation to deviate from its initial goal. Over time, assets that have increased in value will make up more of your portfolio, while assets that have declined in value will make up less. Selling investments that have become overweight in contrast to the rest of your portfolio and reinvesting the proceeds in underweight positions is known as rebalancing.Doing this at regular periods is a smart idea. Clients of Schwab can log in and use the Schwab Portfolio Checkup tool to see whether any parts of their portfolio have strayed from their intended asset allocation.
  • Include safeguards against substantial losses. Simple transitory losses are one thing, but large losses might take years to recover from. When stocks are down, traditionally defensive asset types, such as cash and short-term bonds, do better. They can help protect a portfolio from the effects of up-and-down markets when employed for diversity. Short-term goals or accounts from which you anticipate to draw money within the next several years should also examine defensive assets.

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