Schwab Market Perspective: Bumps in the Road

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The effects of the COVID-19 virus have continued to drive—and brake—economic growth. Stocks sank in early January as investors reacted to the fast-spreading omicron variant and the Federal Reserve’s signals around inflation, including the possibility it will begin “quantitative tightening” much faster than previously expected. However, there are signs that inflation pressures already may be peaking in the United States and Europe.  

U.S. stocks and economy: Roadblocks

The start of the new year has been met with broad weakness across U.S. stock indices as investors digested receding monetary and fiscal liquidity, persistent effects from COVID-19, and a rise—but potential eventual easing—in inflationary pressures. The areas undergoing the most intense selling pressure are the speculative areas of the market, which all gained incredible steam in 2020 and the early part of 2021.

Stocks within “frothier” segments—unprofitable tech companies, companies hit by short sellers (in which an investor borrows and sells a stock in the hope of buying it back more cheaply later), special purpose acquisition companies (SPACs), newer initial public offerings (IPOs), and retail crowd favorites—have weakened substantially over the past year and are now lagging the S&P 500® Index.

Speculative trades unable to catch their breath

Speculative stocks, including those in the Goldman Sachs most-shorted basket, the Goldman Sachs retail favorites basket, the Goldman Sachs non-profitable tech basket, and the Renaissance IPO Index have underperformed the broad-market S&P 500 index during the past 12 months.

Source: Charles Schwab, Bloomberg, as of 1/13/2022.  Goldman Sachs (GS) most-shorted basket contains the 50 highest short interest names in the Russell 3000; names have a market cap greater than $1 billion. GS retail favorites basket consists of U.S. listed equities that are popularly traded on retail brokerage platforms. GS non-profitable tech basket consists of non-profitable U.S.-listed companies in innovative industries. Technology is defined quite broadly to include new economy companies across GICS industry groupings. Renaissance IPO Index is a diversified portfolio of US-listed newly public companies that provides exposure to securities under-represented in broad benchmark indices. IPOs that pass a formulated screening process are weighted by float, capped at 10% and removed after two years. Past performance is no guarantee of future results.

The collapse in performance isn’t shocking if you consider that some of these stocks had outpaced the S&P 500 by triple-digit percentage points (on a rolling 12-month basis) by early 2021. Given the Federal Reserve’s plans to tighten previously accommodative monetary policy (more on this below), the prospect of higher interest rates has dented the performance outlook for companies with elevated stock valuations and/or weak fundamentals.

The Fed is undoubtedly disturbed by current rates of inflation, but some leading indicators are pointing to an eventual easing in prices. For example, the prices-paid index within the Institute for Supply Management’s (ISM) manufacturing index, based on a monthly survey of purchasing managers, declined in December.

Significant improvement in prices paid

The six-month change in the Institute for Supply Management’s Manufacturing Prices Paid Index reached negative 23.9 index points in December.

Source: Charles Schwab, Bloomberg, as of 12/31/2021. The ISM manufacturing prices-paid index is calculated by adding the percent of responses indicating purchasing managers paid more for inputs plus half of those responding that they paid the same for inputs, then seasonally adjusting the resulting single index number. 

The swift drop in the number of companies reporting higher prices is a hopeful sign that headline inflation may soon crest. At least in the goods sector, numerous factors could put the brakes on further price rises: reverse base effects, the slowing pace of increases in commodity prices, and an expected shift in demand from goods to services once the COVID-19 omicron variant subsides.

The unfortunate reality is that the path of inflation (and the economy at large) continues to be driven by the virus, and with omicron rapidly spreading throughout the world, global supply chains—in their already fragile state—are at risk of persistent bottleneck pressures.

Even if omicron remains less severe than prior virus strains, it still may cause a temporary setback for the labor market. The U.S. economy added 199,000 jobs in December. Although the leisure and hospitality sector added the most jobs (53,000), the survey period ended on December 12th, and thus probably failed to capture much of the omicron-related employment weakness, due to restrictions or illness, in the later part of the month. In fact, according to the U.S. Census Bureau’s latest Small Business Pulse Survey, 2.6% of small businesses reported being temporarily closed for the week ending January 2nd, 2022—the highest share since February 2021.

Omicron bit small businesses hard in December and early January

The percentage of U.S. small businesses with a temporarily closed location rose to 2.6% in the week ended January 2, 2022, according to the Small Business Pulse Survey conducted by the U.S. Census Bureau.

Source: Charles Schwab, Bloomberg, U.S. Census Bureau Small Business Pulse Survey, as of 1/2/2022.

The percentage of restaurants closed for the same week was much higher, at 8.1%, according to the survey. That may signal payroll weakness in the leisure and hospitality sector. While it doesn’t mean the job market is set for a marked turn lower, it confirms that the virus—and restrictions to combat it—likely will continue to dictate the pace of economic growth in the near to medium term. 

Fixed income: Fed surprises markets

The bond market has had a rough start to the year. On January 5th, the minutes of the Federal Reserve’s last policy meeting were released and revealed central bankers were considering quantitative tightening—gradually withdrawing liquidity from markets by shrinking the Fed’s balance sheet of Treasuries and other securities—in addition to widely expected short-term rate hikes. Yields have risen sharply for all maturities, but especially longer-term maturities, as the market comes to terms with the Fed’s plans.

Longer-term rates have risen more sharply than short-term rates

Although Treasury yields have risen for all maturities, the greatest increase has been in longer-term yields. For example, 6-month Treasury yields rose about 16 basis points during the first week of January, while 5-year yields rose about 117 basis points and 10-year yields rose about 86 basis points.

Source: Bloomberg, using daily data as of 1/10/2022. Change from 12/31/20 to 1/10/22 at 2:30 pm EST. One basis point is equal to 1/100th of one percent, or 0.01%.

While markets had already priced in three rate hikes this year, the prospect of quantitative tightening in 2022 was a surprise because it’s a departure from the Fed’s approach in the past cycle. After the 2007–2009 financial crisis, the Fed waited two years after its first short-term interest rate hike to start letting the balance sheet shrink. However, there is much greater urgency this time around because the economy is growing at a healthy pace, the job market is strong, and inflation is at its highest level in decades. Moreover, this cycle is starting with extremely loose financial conditions and negative real (adjusted for inflation) interest rates.

Chicago Fed National Financial Conditions Index shows easy conditions

The Chicago Fed National Financial Conditions Index spiked during the 2007-2009 financial crisis, when lending tightened. Despite several upward blips in subsequent years, notably during the COVID-19 pandemic, the index shows very easy financial conditions.

Notes: The Chicago Fed’s National Financial Conditions Index (NFCI) provides a comprehensive weekly update on U.S. financial conditions in money markets, debt and equity markets and the traditional and “shadow” banking systems. Positive values of the NFCI indicate financial conditions that are tighter than average, while negative values indicate looser-than-average financial conditions. This figure plots the NFCI, along with contributions to the index from the three categories of financial indicators (risk, credit, and leverage). The contributions sum to the overall index.

Source: Federal Reserve Bank of Chicago.  Chicago Fed National Financial Conditions Index, Index, Monthly, Not Seasonally Adjusted.  Monthly data as of 12/31/2021.


As we indicated in our 2022 Fixed Income Outlook, the move away from very easy monetary policy is likely to boost volatility. With ample liquidity and low interest rates, riskier segments of the markets have outperformed risk-free assets, such as Treasuries, over the past year. However, that dynamic should change with tighter policy. The challenge for the Fed is to try to slow inflation without tipping the economy into a recessionary downturn.

Based on the recent indications from the Fed, we expect to see the federal funds rate increased three times in the year ahead, perhaps starting as early as March. If growth remains strong and inflation high, then the Fed will likely begin to allow bonds to mature off its balance sheet in the second half of the year. We would expect the Fed to cap the dollar value of the bonds it allows to roll off the balance sheet due to the large amount of bonds maturing in the next few years.

Large amounts of Treasuries will mature during the next few years

More than $1 trillion of Treasuries on the Fed’s balance sheet will mature in 2022, with about $800 billion maturing in 2023, and more than $500 billion maturing in 2024.

Source: Bloomberg. Federal Reserve SOMA Maturity Distribution. Data as of 12/31/2021.

The Fed also has the option to sell bonds outright, to prevent the yield curve from inverting (when short-term yields rise higher than long-term yields). Historically, when the Fed is hiking short-term interest rates, the yield curve flattens. Long-term rates tend to rise less than short-term rates, or even to decline, because tighter monetary policy signals slower growth and lower inflation down the road. An inverted yield curve historically has preceded recessions. Consequently, the Fed likely will focus on managing its tightening policy to allow long-term rates to stay above short-term rates.

The yield curve has been in a flattening trend over the past year

The yield spread between two-year and 10-year Treasury securities is roughly 90 basis points, down from levels as high as 157 basis points in the first half of 2021, as short-term yields rose and flattened the curve in the second half of 2021.

Source: Bloomberg. Daily data as of 1/10/2022. This graph shows Market Matrix U.S. Generic spread rates (USYC2Y10). The spread refers to the difference in yield between the 2-year U.S. Treasury note and 10-year U.S. Treasury note, a common measure of the steepness of the yield curve. The spread is adjusted by a factor of 100 for clarity. Past performance is no guarantee of future results.

We continue to suggest that investors keep the average duration in their fixed income portfolios below their benchmark indices. However, as yields move higher in response to Fed tightening, buy-and-hold bond investors can consider adding some intermediate- to long-term bonds to their holdings. We see rising bond yields as a potential opportunity for investors with long time horizons.

Global stocks and economy: Europe’s Q1 risks

New COVID-19 variants, such as omicron, are posing an increasing near-term risk to the global economic outlook. European economic reports released in December, which primarily cover activity during the month of November, generally exceeded economist expectations. However, high-frequency data, such as dining reservations on OpenTable’s system in Germany, reveal the drag of the latest COVID-19 wave on services industries in December. When December services data is released in January, results may be disappointing.

German service sector is feeling the impact of omicron

The 7-day average percent change in the number of restaurant reservations in Germany made on the app fell by 40% in December compared with the same day in 2019.

Source: Charles Schwab, data as of 1/9/2022. 

The virus probably weighed on services demand in the fourth quarter of last year and may continue to have a negative impact in the first quarter of 2022. But the potential hit to growth from the latest COVID-19 wave is likely to be followed by a rebound in the second quarter, aided by sustained fiscal support, an elevated pace of consumer consumption driven by pent-up savings, and inventory rebuilding.

While COVID-19 remains a risk to the growth outlook, other first-quarter risks may be easing:

  • Inflation is set to fall sharply in the eurozone in the first quarter on a year-over-year basis, as the impact of last year’s sales tax increase in Germany fades and caps on energy prices kick in.


Economists’ inflation expectations point to sharp reversal

The consensus forecast for eurozone Consumer Price Index year-over-year growth, a measure of inflation, has dropped sharply. Inflation growth is now expected to decline to just over 1% in 2022.

Source: Charles Schwab, Bloomberg data as of 1/9/2022. Forecast reflects Bloomberg-tracked economist consensus estimates.

  • Supply chain risks seem to be fading. The December eurozone manufacturing purchasing managers index (PMI) data by IHS Markit revealed that inventories of raw materials and other semi-finished inputs rose at the fastest pace in the 24-year history of the survey.
  • Concerns of political instability seem to be softening. Concerns about a sudden political vacuum in Italy seem increasingly overblown. Meanwhile, in France, the April presidential election appears unlikely to feature a challenger from France’s far-right, and its potential to destabilize eurozone relations.

While European stocks hit a new all-time high on January 5th, analysts have been delaying further increases to earnings estimates for the fourth quarter. Since the identification of the omicron variant in late November, analysts’ Q4 earnings estimates for companies in the STOXX 600 Europe index have stabilized, after a steady climb for most of 2021. As companies report their fourth-quarter results in the coming weeks, we will learn more about the effects of COVID-19, along with any inflation and supply-chain issues that may set the tone for both earnings estimates and stock prices in the first quarter.

Personal finance: Get financially fit in 2022

A new year typically brings resolutions, such as making healthier choices and getting fit. However, a fitness plan doesn’t have to mean overhauling every aspect of your life. Incremental, healthy changes that you can stick to are the ones that lead to long-term success.

It’s the same with personal financial planning—it’s not a one-time event, but a lifelong process. Even small changes can pay huge dividends over time. As the new year begins, consider taking a few steps to make yourself financially fit in 2022. Our Personal Finance Calendar for 2022 offers month-by-month ideas for budgeting, planning for retirement, and more.

For January, think about:

  • Managing debt. Consider paying off high-cost, non-deductible credit card debt, then establishing an emergency fund equal to three to six months of expenses, if you haven’t already.
  • Giving your portfolio a checkup, and make sure its mix of assets still matches your time horizon and risk tolerance (Schwab clients can log in and use the Portfolio Checkup tool for this). Market changes can cause your portfolio to drift away from its original target asset allocation because as investments gain and lose value, they become a larger or smaller part of your overall portfolio. Rebalancing—that is, selling assets that have appreciated and putting the proceeds into assets that have underperformed—can correct this, preparing your portfolio for a changing market environment in which previous outperformers may lag and previous underperformers may do well.

If the recent bumps in the road should lead to more market volatility in 2022, now may be an especially good time to rebalance your portfolio back to your chosen asset allocation. While rebalancing and asset allocation strategies can’t ensure a profit or protect against a loss, they can help buffer your portfolio in rough markets.

Kevin Gordon, Senior Investment Research Specialist, contributed to this report.

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