Investors have had to contend with a volatile start to 2022 in US stock markets.
Earlier this week, the 10-year US Treasury yield hit a two-year high amid anticipation of faster interest rate hikes by the US Federal Reserve (Fed).
In early trading on Wednesday (19 January), the 10-year Treasury yield hit 1.9% but the spike eased to around the 1.8% level by Thursday.
Despite that, concerns around the timing of the Fed’s tightening of monetary policy, as well as rising inflation, is likely to keep the Treasury yield elevated.
The anticipation of higher yields has already affected the broader market, which has seen a weak start to the year, especially for those stocks in the technology space.
The Fed is now under pressure to tackle rampant inflation with faster rate hikes.
Besides that, the prospects of an early start to reduce the size of the Fed’s balance sheet is another concern.
This could potentially lead to an early withdrawal of liquidity, which will have a negative impact on asset prices.
What to expect for the market?
It is vital to look into your asset allocation strategy as we enter the policy rate hikes cycle this year.
As we have seen at the start of the year, volatility is here to stay until some clarity is seen on how the Fed will move ahead with its tightening path.
1) Stocks remain more attractive than bonds
The pace of the Fed’s tightening will have a negative impact on both equities and fixed income but given the duration risk related to fixed income, equities remain a better play to generate a positive return this year.
However, I think investors need to moderate their expectations as the transition to normalcy in 2022 is likely to come with a lower return for risk assets.
2) Growth or value stocks?
The easy answer is this: The outlook for the Fed, interest rates and economic growth show a dynamic that support value stocks as compared to growth stocks.
However, once US growth moderates towards normalisation at the end of this year, investors might shift their focus back towards growth stocks.
I think the actual answer to this is much more complex as it depends on our existing portfolio allocation.
If you are already invested in growth stocks, it might make sense to follow the rotation play into value stocks.
For a new investor, though, a balanced exposure to both value and growth would be the better strategy over the long term.