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The culprit here is a growing expectation that the Federal Reserve will hike interest rates sooner than anticipated. The hardest-hit stocks so far are the “long-duration” stocks, mainly technology shares that trade at rich valuations.
The yield on the benchmark 10-year U.S. Treasury bond soared from just 1.5% on New Year’s Eve to 1.8% today. That’s an increase of 20% in the interest rate that is widely used as a benchmark for mortgage loans and other consumer lending.
The rapid rise spooked investors in both stocks and bonds last week and will be a hot topic of concern this year along with inflation.
Last week, the S&P 500 Index dropped 1.9%, but the tech-heavy Nasdaq Composite Index slumped 4.5%. This is a classic “bird in the hand is worth two in the bush” scenario. Earnings today are worth more to investors than earnings tomorrow – or a few years from now – due to rising rates and inflation.
That’s why it’s no surprise that technology stocks, measured by the SPDR Technology Select Sector ETF (XLK), got clipped for a 4.6% loss last week. And the sector is down 8.7% over the last two weeks. Many tech stocks have sky-high valuations based on the promise of future earnings.
But higher interest rates make those future earnings less valuable today.
There is a major shift taking place, where capital is moving from growth (tech) stocks into more cyclical value stocks.
And such a disappointing start to the year could be a bad omen for stocks in 2022, but it also may not be the end of the world.
Since 1980, whenever the S&P 500 is up during the first five days of January, its average full-year return is +13%, according to analysts at DataTrek Research.
On the other hand, when the first five days are down, as they were last week, the average full-year return is just +5.6%.
In other words, when January gets off to a good start, the annual return is more than double the annual return seen during years when stocks have a poor start.
But even when the S&P is down the first five days of January, the index still ends the year higher more than 70% of the time. So all is not lost.
Still, inflation and higher interest rates seem to be a major concern for financial markets as 2022 gets underway. As a result, we are likely to see more volatility in stocks and bonds this year.
With that in mind, it makes sense to use our powerful TradeSmith tools to reduce the volatility and risk in your stock portfolio. Here’s how you can accomplish that.
First, by using our market analysis tools, you’ll see that despite last week’s volatility, more than 70% of stocks in the S&P 500 Index are still in the Green Zone and in a healthy state. That’s a very positive sign for the overall market.
Second, you can run a stock screener that shows all of the S&P stocks that are now in the Green Zone and rated Strong Bullish. These are the top stocks in the index in terms of our unique Health Indicator and Rating system.
But not all of these top stocks are created equal.
Some are more volatile than others. And with the market off to a poor start already, you may want to consider focusing on stocks with a lower Volatility Quotient (VQ%).
The lower the number, the more stable the movement of that stock. Here’s a handy breakdown of the different VQ% levels:
Up to 15% = Low risk
15%-30% = Medium risk
30%-50% = High risk
50% or above = Sky-high risk
Many of the stocks with high and sky-high risk ratings are the same stocks currently getting hit with selling pressure due to rising interest rates.
So you may want to avoid these stocks, or at least consider reducing the number of stocks you hold that have a high VQ%.
Here’s a sample of a screen I ran yesterday on the S&P 500, sorted by VQ%.
You’ll notice that many of these are stocks that have stood the test of time, even in volatile markets. They are all rated Strong Bullish or Bullish, and all of them are considered low or medium risk in our system.
Most of these stocks are also from defensive sectors, like Consumer Staples, that are considered less risky. And that can be a big plus for you in turbulent markets.
Another bonus is that many of these stocks offer an attractive dividend yield, most in the 2% to 3% range. And higher cash dividends tend to help insulate these stocks even more from volatility.
2022 may be off to a rocky start, but that doesn’t necessarily mean this will be a bad year for the stock market. Still, you may want to consider stocks for your portfolio that are less volatile until markets settle down.