Many of us overindulge at Christmas and regret the effects in the New Year. So far in 2022 it feels as if global stock markets are suffering similar troubles.

    After racking up double-digit returns in 2021, including rather merry performance right through the month of December, the MSCI All Country World Index returned -4.0% in January.

    If only the pounds dropped off waistlines quite as quickly as they have from market valuations…

    What has driven the recent turbulence? In a word, or rather two: interest rates.

    Expectations have shifted a lot in a relatively short period. Back in September, the market was pricing in a single rate hike from the Fed this year. At the time of writing in early February, the expectation is for around five.

    It’s the sheer speed of this turnaround that has caused the recent ructions in the market.

    For the best part of three decades, investors have believed in the ‘Fed put’. This is the notion that the central bank does not much like it when the market falls and will step in to try and shore it up when times get tough – whether that be through cutting rates, printing money or even just uttering some reassuring words.

    What seems to have spooked markets of late is that the Fed notably chose not to do this when it had the chance – even in the wake of various US indices falling into, or around, correction territory.

    In fact, at the latest meeting of its key committee, the Fed went as far as to commit to raising rates in March “assuming that conditions are appropriate for doing so”.

    There was also a hint that quantitative tightening is likely to begin earlier than previously expected too. (As the name suggests, this is the opposite of the quantitative easing process. It refers to the bonds which were bought under QE maturing and not being replaced with new stock, thus shrinking the Fed’s overall portfolio of assets)

    What’s more, in verbal remarks after the meeting, Chair Jerome Powell stated baldly that the US economy “no longer needs sustained high levels of monetary policy support”.

    A change in the investment environment is now clearly in the offing. And it’s well known that market performance has often been correlated with market liquidity, particularly in recent years. So what might give us confidence that the show can be kept on the road?

    Crucially, a few key factors point to a probable peak in inflation in the coming months.

    First, inflation indices are most commonly measured by comparing prices in a given month with the equivalent figures a year previously. It’s therefore likely that the impact of elevated energy prices – which have made a considerable contribution to recent high rates of inflation – will gradually drop out of the figures over the course of the year.

    The disruption to global supply chains and demand patterns wrought by the pandemic, which has pushed up prices for both goods and distribution, will come to an end eventually. This is a development that should be accelerated by the (thankfully) milder nature of the Omicron variant of the novel coronavirus.

    Elsewhere, China appears to be shifting back to easing its fiscal and monetary policy stance to support economic growth. This could serve to reduce the value of the country’s currency in foreign exchange markets. If so, that would cut the cost of importing goods for the rest of the world.

    These effects, in concert with the Fed’s hawkish turn, may well limit the overall degree of tightening which is required by the end of the cycle.

    That would be supportive for asset prices in general.

    With this in mind, it could be worth reminding investors that many of the same principles apply to long-term financial planning as to shedding the post-Christmas bulge.

    Stick to a clear plan. Don’t panic and throw in the towel if you go through a difficult patch. And whether it be financial security or a set of toned abdominals… keep your eyes on the prize!

    Where referenced, market returns are quoted gross in Sterling terms.
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