Week Ahead: Earnings, Central Banks, Trader Uncertainty To Drive Volatility

Though most stocks rebounded on Friday to finish the trading week, and the S&P 500 and Dow Jones each arrested losses on a weekly basis for the first time in three weeks, daily activity was often wild and in some cases filled with reversals.

We expect additional, significant volatility in the coming week as bulls and bears continue to duke it out over market direction, after the sharp equity market selloff that's taken hold thus far in January.

Some investors might view the deceleration as a buying opportunity. Others, however, may be spooked, fearing an extended meltdown.

During the course of the past week, the SPX lost as much as 4%, but finished up 2.43% for the day on Friday, closing +0.77% for the week. After tumbling as much as 9.8% from its Jan. 3 record close, even at one point scraping at the 10% boundary signifying correction territory, the broad benchmark closed out the week 7.01% below its record high.

The mega cap Dow Index gained 1.65% on the final day of last week's trade, to advance 1.34% on a weekly basis. The move followed a 3.14% midweek dive. The 30-component blue chip index outperformed peer US indices on both a daily and weekly basis. For its part, the Dow fell 7.17% from its Jan. 4 record at its lowest point, but is now 5.63% below that peak.

The NASDAQ finished Friday +3.13% higher, gaining 0.11% for the week. This may seem like a paltry move in absolute terms, but considering the tech-heavy index came back from a 4.91% plunge over the course of last week, it's actually an impressive feat. The index lost 15.51% from its highest ever closing price on Nov. 19 but as of Friday's close is now -12.71% from that level. Nevertheless, the tech benchmark underperformed on a weekly basis.

The small cap Russell 2000 finished up 1.26% on Friday, jumping +0.98% for the week, having bounced back from a 4.35% loss during the week. From its Nov. 8, 2021 record close to its closing price this past Thursday, the small cap index fell 20.94%, to at least briefly enter a bear market. Friday's rebound brought the gauge up to -19.41% from its record close.

Here are our takeaways from analyzing the relationship between the various performances of the major indices:

1. The two indices that have gained the most in the past year—the Russell 2000 and the NASDAQ—represent both sides of the Reflation Trade, which means each has the most to give back now.
2. The Dow represents value shares that were severely discounted by investors during lockdowns, similar to the Russell 2000. But the DJIA provides access to mega cap company shares, which don't have the same limitations during social restrictions as the smaller domestic firms listed on the Russell 2000 Index.

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The question investors must now answer for themselves is whether pullbacks will continue to pay off by providing buying opportunities, as they did during the Fed's easing period—the loosest central bank monetary policy in history. Now that the market is pricing in four, possibly five rate hikes by the end of 2022, there is reason to believe the equity market might not necessarily behave as it did previously, when liquidity was plentiful.

This once seemingly endless money supply kept a lid on its value, plus the lowest interest rate on record—something we will likely never see again, hopefully—acted in tandem to propel stocks to new, frothy heights. Now, the reduced supply of money will increase borrowing costs even as interest rates increasing make the price of borrowing even more expensive.

As for valuation multiples, after the January selloff to this point, the S&P 500 is valued at 19.5 times earnings, compared to 22 times earnings in late December, near its highest levels in 20 years. The five-year multiples average is 18.5 times earnings.

Some analysts, including those at Barclays don't think the selloff has yet presented a buying opportunity. They anticipate an additional 8% decline from current levels.

After the Fed turned hawkish, Treasury yields jumped, triggering the recent selloff. Rising yields are a strong indicator of upcoming rate hikes, which make debt more expensive for companies and decreases the reasons for investors to keep supporting high-priced stocks.

Also, higher, guaranteed bond payouts—such as for the US 10-year benchmark—siphon investors away from volatile equities. Indeed, after wiping out pandemic losses, having reached the highest levels since December 2019, yields are gearing up to extend their advance.