Markets

Here's Why Stocks Are on Such Shaky Ground to Start January

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It was a wild day for stocks on Monday, adding to the market's shaky start to 2022.

The Dow Jones Industrial Average fell as much as 1,000 points, before coming back to close about 100 points higher. The S&P 500 was off by nearly 4% at its session low but managed to eke out a small gain. The Nasdaq Composite rose 0.6% after falling as much as 4.9%.

Despite the late-day jumps, both the Dow and S&P 500 are on pace for their worst month since March 2020, when the market fell into turmoil amid the pandemic. The Nasdaq, meanwhile, is still headed for its biggest one-month loss since October 2008.

What's behind the market's weak start to the year?

Though some areas of the market considered more expensive or speculative began to struggle in November, the broader market took a big step back during the first week of January following increasing hints from the Federal Reserve that the central bank will take aggressive action to slow down the jump in consumer prices.

"Over the past month, the Federal Reserve (Fed) has made it increasingly clear that it is serious about fighting that inflation," the Wells Fargo Investment Institute said in a note to clients on Jan. 19.

The central bank has signaled that it plans to stop its asset purchases, hike rates and possibly reduce its balance sheet, starting in March. Government bond yields have surged in preparation for the rate increases, with the U.S. 10-year Treasury rising more than 40 basis points this year alone to nearly 1.9% at its high point after finishing last year just above 1.5%. (1 basis point equals 0.01%.)

Investors are now expecting four rate hikes this year, with some officials warning that more may be needed, after most Wall Street pros expected just one or two hikes a few months ago.

"The Dec. 15 minutes that came out on Jan. 5, they were a shock to investors," Ed Yardeni, founder of Yardeni Research, said on CNBC's "Halftime Report" on Monday.

The Fed will give its latest update on Wednesday. While it's unlikely to raise rates at this meeting, market experts believe the central bank will stick with its plan tighten financial conditions despite the market decline given the high level of inflation.

Concerns about persistent inflation, supply chain disruptions from new Covid variants and the potential for conflict in Ukraine are other factors that have weighed on the risk appetites for investors.

Tech leads the way down

Technology stocks with high valuations got hit first and are continuing to get hit.

Last week, the technology-focused Nasdaq Composite fell into correction territory, marking a 10% drop from its November 2021 record close. At one point on Monday, the index was just a few percentage points away from reaching a bear market.

Climbing bond rates typically disproportionally punish growth stocks as their future earnings growth become less attractive as rates rise. The growth expectations for tech stocks have also weakened as Wall Street analysts have gotten a better sense of what the post-pandemic economy may look like.

"Since the end of 3Q21, 2022 earnings estimates for [the Nasdaq 100] fell 0.8%, while estimates for the S&P 500 rose 1.9%, indicating weaker fundamentals for Growth stocks relative to the overall market," Bank of America equity and quant strategist Savita Subramanian said in a note on Monday.

Many of the biggest stocks in the market are tech names, so their declines can have a major impact on market averages. Now, the selling pressure is feeding on itself as investors dump risk assets, dragging every stock sector but energy down in January.

The cryptocurrency market has been hit hard as well. The price of bitcoin fell briefly below $34,000 on Monday morning, bringing its year-to-date losses to roughly 30%. Since its record high in November, the largest cryptocurrency has lost about 50%.

Bitcoin has lost roughly 50% since its all-time high in November.
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Bitcoin has lost roughly 50% since its all-time high in November.

The price of ethereum has seen a similar decline over that time period.

Bright spots

To be sure, the health of the economy is looking good. The unemployment rate has fallen to 3.9% after a record year of nonfarm payrolls growth. Other metrics of economic growth are positive, even if they show a slower recovery than in 2021.

Earnings season is also turning out to be a strong one, despite some disappointing reports from high-profile firms. More than 74% of S&P 500 companies that have reported results have topped Wall Street's earnings expectations, according to FactSet.

Covid-19 cases are also coming down. After exploding to staggering new highs amid the spread of the highly transmissible omicron variant, Covid-19 cases started to come down in New York State over the last two weeks, according to Gov. Kathy Hochul, leading to hope that other areas of the U.S. can see a similarly quick wave.

-CNBC's Michael Bloom contributed to this report.

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