Crunch time for stockmarkets as interest rates rise

Stockmarkets, having been puffed up by ultra-low interest rates, are in for a rough ride as the world’s central banks start to raise them.

Storming the US capitol building
Last year began with an insurrection in the US, but markets shrugged it off
(Image credit: © Samuel Corum/Getty Images)

Last year was 12 months of “insurrection, infections and inflation”, says Randall Forsyth in Barron’s. But you wouldn’t think it from looking at the markets. America’s S&P 500 index finished the year up nearly 27%. The rally has been a testament to the “power of money, conjured and created by central banks” – money that has funded government borrowing “on a scale never experienced in peacetime” and sent assets to record highs.

Time and again, investors “brushed off” news that would have “derailed” previous bull markets, say Anna-Louise Jackson and John Schmidt on Forbes. A contested US election, historically high inflation, broken supply chains and a “still-raging” pandemic all failed to upend stocks. The S&P 500 recorded “70 all-time highs in 2021”, the highest number since 1995. The frenzy spilled beyond Wall Street: the total market capitalisation of cryptocurrencies tripled last year. Bitcoin ended the year up 60%.

Volatility ahead

Global financial markets are entering “a new phase” in 2022, says Katie Martin in the Financial Times. The start of the pandemic in 2020 brought crisis and a short but brutal bear market. Then central banks “flooded the system with stimulus”, which has driven a 20-month period of “runaway returns”. Now we have “crunch time”. The Bank of England has already hiked interest rates, with others likely to follow. If 2021 was an unusually calm year in markets, we should expect that the next 12 months will bring much nervier trading.

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Central banks hope to spend 2022 slowly weaning investors off easy money, avoiding big financial upsets along the way. That may not be easy. “The nightmare scenario is: the Fed tightens and it doesn’t help,” says Aaron Brown, a former trader and risk manager who now teaches at the Courant Institute of Mathematical Sciences, in The New York Times. If policymakers can’t bring about a soft landing for the economy and inflation continues to rip, the Fed might be forced into “very aggressive action like a rate hike to 15 percent, or wage and price controls, like we tried in the 1970s”.

A long way down

Last year’s returns were powered by a strong earnings rebound, says Sam Goldfarb in The Wall Street Journal. US corporate earnings rose about 45.1% year-on-year in 2021. Growth is forecast to fall to 9.2% this year, according to data from FactSet. That would still be as good as 2017 (when the S&P 500 gained 19%), but highly valued US markets may now be more vulnerable to higher interest rates. “By some measures, stocks now trade at their highest prices relative to companies’ earnings since the late 1990s’ dotcom bubble.”

It doesn’t take “an investment genius” to see that stocks, “all puffed up by ultra-low interest rates”, are in for a rough ride as central banks normalise rates, says Jeremy Warner in The Daily Telegraph. Policymakers have been caught napping by inflation, which is running at 5.1% in the UK and 6.8% in America. It’s likely that they will “have to act much more robustly to tame the inflationary tiger”. That “would spell big trouble for stock prices”.