Is This Another 2018 Case Scenario?

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Possibly yes, but it seems to be different this time.

Towards the end of 2018, the markets appeared to perform badly for a prolonged and sustained period of time. No matter where you’d invest, the outcome was almost always the same. In fact, The S&P500 index had corrected itself by about 20%, whereas big-tech companies with the likes of Facebook had fallen around 40% to a share valuation of roughly $140 per share. 

So What Exactly Happened In 2018? And What Could Make This Situation Similar? 

Well, first off, in mid-2018 the fed underwent a series of interest rate hikes in order to combat inflation and ensure steady growth of the American economy, and subsequently many other leading global economies (who also hold US dollars as their reserve currencies). 

The hikes in the interest rates started in 2016 and steadily increased throughout the years. Leading up to the end of 2018 were rates stood at 2.5% — highest level since the spring of 2008.

When the fed increases the interest rate levels it tends to be counterproductive towards the stock market. This is for many reasons, but generally, it increases the cost of organisations to carry out their business and increases the cost to acquire debt (loans and other forms of finance). 

On the contrary to this, however, when the fed manage to find a sweet balance between the rate at which money is printed (without causing undue inflationary pressure on the economy) the stock market tends to perform well. 

The above diagram illustrates the increase in the feds rates in 2016 leading to the end of 2018 where the rates stood at 2.5% 

As a corresponding reaction to the increase in the Fed’s interest rates, the market performed badly in 2018. 

However, in 2019, the fed readjusted its interest rates back to 1.5% and that fared well with the stock market, with the S&P500 increasing 40% leading up to the ‘covid-19 crash’. 

So from these charts, the situation in 2018 could be said to follow a somewhat predictable pattern — interest rates increase, the stock market performs unwell, and vice versa. Does this however give us insight into what may happen in the near future?  — possibly but definitely not certain. 

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Looking At 2022 & Beyond

Throughout 2021 we have been seeing the inflationary household index slowly but steadily increasing, until not too long ago Jerome Powell (chair of the US federal reserve) stated that this index now stands at approximately 6.8% in the US. 

The reason for this jump can partly be blamed on the shortage of labor within the market, and other material supply shortages (such as microchips). In addition to this, global governments took to the scene and produced stimulus money to ease the pressures on the economy brought about by the pandemic. 

In response to the increase in inflationary pressures brought about by the above scenarios, the fed has now started to intervene with a plan to increase the interests rates and recontract the additional liquidity injected into the economy during the pandemic.

So what can we expect? 

Well, for one part we can expect to see similar reactions from the stock market now as we did in 2018, that is, as interest rates increase, the stock market may not do too well — but to what extent, and to what measures the fed will go to in order to reduce inflationary pressures remains to be seen.

For reference purposes, the inflation indexes in 2018 stood at 2.4% a very sizeable difference when compared to the 6.8% we’re currently witnessing. 

It May Be All In The Hands of Omicron 

At least for the foreseeable future. Here’s why. 

Omicron has taken the world by surprise with it (the virus) being dubbed as the most contagious variant to mutate. Where things stand will require a bit of a guessing game, but let’s use two assumptions to predict a possible outcome. 

1. Lock Down

If the omicron variant excels to the point where healthcare centers are being overwhelmed (forcing the economy into lockdown), then the fed may be pressured into holding back on the interest rate hikes, and to keep consumer confidence high. 

However, the sustainability and longevity of this method will be questioned. It would quite simply be shoving the problem under the carpet in the near term. 

2. No lockdowns

If the economy continues to perform at current trajectories, and lockdowns aren’t enforced, then we might continually see increases in interest rate hikes until the supply shortages start to ease, and inflation is maintained well. 

To Wrap it all up

The world is currently seeing inflation spike up to historic levels and that is not a good thing, both for the average consumer and also the stock market investor. 

The market may have a turbulent time ahead of it as we come to grip with the current supply bottlenecks, inflation, and as governments continue to engage in a tug-of-war battle with a global pandemic. 

Companies that have particularly high valuations may be facing difficult times ahead as sentiment towards the market changes, and if it (the stock market) is negatively impacted by the increase in interest rates. 

It may be (but definitely not a certainly), a good idea to look at companies who may benefit from the increasing interests rates in the near term as the supply bottlenecks start to ease themselves in the plausibly distant future. These may include organisations that are well established, have strong balance sheets, with little debt and large cash balances, and whose business models seem to be lightly impaired (if any) by the uncertainty of it all. 

This is not financial advice, we are just pointing your attention towards what has happened in the past when the federal reserve increased the interest rates in order to combat inflationary pressure. The outcome of this going forward is uncertain, and as I’ve previously stated, your guess is as good as mine. With the inflationary pressures being stated at 6.8%, it may be possible to assume a more aggressive approach by the fed to combat inflation than they had adopted in 2018. 

What we do know for sure is that the Fed will face a time when they have contained and managed the inflationary pressures, and even more so, start reducing the interest rates —  The growth of global economies depends on it. 

With that being said It may be a good time to fish for bargains as and when they arise, but that is something we will leave to you.