Recent market jitters will have most investors nervous. On Monday, the S&P500, which tracks the broad market, closed at 4410, down from its peak by almost 8%. Meanwhile the NASDAQ, which measures high growth technology stocks, was hit even worse, closing at 13,855, down almost 12.5% off its peak.

It is always hard to figure out what drives sell-offs, but this one appears to have been pushed by investors worrying about inflation and rising interest rates in 2022. Every few weeks, the markets seem to raise their expectations of Federal Reserve rate hikes in 2022; in October the markets expected a single rate hike by the end of 2022. By early January, they were expecting three — and last week that was revised up to four.

The markets themselves are incredibly overvalued. Before the recent selloff, they were registering a reading of nearly 40 times on the popular Shiller PE metric — a reading that had only been beaten once before in history when, at the height of the dotcom mania, the Shiller PE went above 44.

That said, valuations may be a useful guide to what stock prices are likely to do over the next few years, but they are not good for assessing when that turning point will come — or even if it is already upon us. The best way to gauge the severity of the recent selloff is to compare it to other recent selloffs. Take the S&P500 first. Since 2012, we have 38 worse selloffs than the current one, but most of those occurred during the actual crash as the pandemic emerged in early 2020. If we are to exclude those, then we have seen 15 worse selloffs since 2012. So while the recent selloff is pretty severe, it is nowhere near record breaking relative to recent history.

The NASDAQ looks a lot worse. Since 2012, we have only seen 16 selloffs worse than what we have just experienced. But crucially, all 16 of these were in early 2020. This means that, if we exclude the market crash in early 2020, the NASDAQ is experiencing its worst selloff in the past decade. This is of particular concern because the recent market boom has generally been led by high growth tech stocks.

What is more, the three largest stocks on the NASDAQ have all taken a hit. Apple and Microsoft are marginally down, but Amazon is having a torrid time —its price has fallen nearly 23% in the past six months. This is due to post its fourth quarter earnings in early February, and markets appear to be factoring in bad news. This is likely markets waking up to the fact that the lockdowns are coming to an end and delivery services like Amazon can no longer rely on outsized earnings.

Some might counter this and say that lockdowns being lifted is good for the economy. This may be true, but it is unlikely to be good for corporate earnings. In fact, the lockdown has led to record corporate profits, as seen in the chart below. These profits have been driven by companies that have benefited from the lockdown.

There is some enthusiasm for stock in companies that were particularly hard hit during the lockdowns, like hotel and travel stocks. However, many of these companies had to load up on debt during the pandemic and might be particularly sensitive to rate rises. But regardless, they are just not big enough players to impact the overall market. The so-called FAANG stocks in the technology sector have a market cap of around $7.4trn; the market cap of the ten largest travel companies is just over $460bn or around 6% of the FAANGS.

In summary then, the evidence seems to suggest that two things are happening at once. On the one hand, markets are getting wise to the prospect of continued inflation and rate hikes in 2022. On the other, they are realising that many of the tech stocks leading the show are running out of steam as the world returns to normal. Is this the beginning of the end? That is impossible to say. But 2022 is going to be a hard year to keep the ever-shifting bullish narrative driving markets going.

---

Philip Pilkington is a macroeconomist and investment professional, and the author of The Reformation in Economics

philippilk

---