3 Assets That Have The Most To Fear From The Fed

Feb 02, 2022

A week is nearly a lifetime in the financial markets.

The market convulsed last week at the prospect of the Fed shifting away from crisis-era stimulus toward tightening for fighting inflation, with equities dropped at the prospect of higher interest rates.

On Monday, Wall Street's risk appetite slowly returned. While investors are still digesting the consequences of the next rate rise round, they are once again in a buying mode (at least for now). The comeback was driven by battered tech companies, with the Nasdaq's 3.1 percent gain just escaping its weakest January on record and delivering its strongest day of the year so far.

While markets have recovered slightly, the impact from January's sell-off is likely to persist. Indeed, it is possible that things may worsen further from here.

"It's hard to forecast the market's next moves, but I believe there is downside risk, and active management has a significant advantage at the moment in terms of cherry picking and stock picking and differentiating between the names," Lauren Hill, Westwood Group's consumer/retail analyst, said.

With the central bank wearing its armor in order to kill the dragon known as inflation, the only remaining uncertainties are how much and how soon rates will climb.

Wall Street is updating its prediction for the central bank's rises at the fast pace — with Bank of America analyst Ethan Harris saying that the institution anticipates as many as seven increases in 2022.

Whether the Federal Reserve continues to play small ball or becomes more hawkish is an unanswered question. Whatever the case, the upcoming age of monetary tightening will have investors scrambling to catch numerous falling knives, and we haven't even begun to touch the surface of how average buyers will respond to increasing borrowing costs.

Considering these factors, the following asset classes seem to be the most vulnerable:

Stocks

Sam Stovall of CFRA Research informs that January is an excellent indicator for the year's temperature. And the instability that has rattled equities since the 2022 start has wreaked enduring damage that will be difficult to get rid of.

"Three indicators popularized by The Stock Trader's Almanac — the Santa Claus Rally, the first five days of January, and the January barometer — provide insights into the performance of the US stock markets in the upcoming calendar year," Stovall noted.

"This year's Santa Claus Rally happened, only to fade within the first five days of the new year and continue weakness throughout the whole January. Since 1945, on eight occasions this combination happened, the S&P 500 fell 9.6% for the whole year, down in all but one year (2014)," he noted.

"Investors may be rewarded with a short-term relief surge. Sadly, this increase will almost certainly not be the end of the downturn," the expert warned. Caveat emptor (Let the buyer beware), as the old saying goes.

Crypto Assets

Over the weekend, it was discovered that a new cryptocurrency protocol dubbed Tornado Cash was a key to at least one high-profile ethereum hacker attack. It serves as a sharp warning that during periods of market instability, incidents of fraud, theft, and criminal activity increase in frequency, and cryptocurrency is no different.

"The crypto correction demonstrates that bitcoin and other digital currencies are becoming increasingly connected with traditional financial market indicators," Goldman Sachs' Zach Pandl commented last week.

"Over time, further advancements in blockchain systems may create a long-term tailwind for some virtual asset prices. However, these securities will be susceptible to macroeconomic influences, such as Fed tightening," Pandl noted.

Housing

Where people live and how much they pay for it is becoming a more pressing issue in an inflationary economy poised to be upended by increased borrowing rates.

The Economist rightly notes in its new edition that the impact of rising rates on the real sector is slower and more difficult to predict, with homeowners burdened with large mortgages taken on during a "super-cheap money" period, which is about to end.

While the real estate market has been providing contradictory signals, 30-year mortgage rates remain around their peaks in over two years, having increased by more than half a percentage point in a month. At the same time , the hot property market is driving up rental rates throughout the nation, which is a big component of the inflation narrative.

"You've got a lot of people that are possibly being priced out of the real estate market," RentPath chief executive officer Jon Ziglar mentioned. So what happens to that effect when interest rates begin to go up? Truly, buyer beware.

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