Is it what goes up must come down? Direction of US stocks and commodity investment strategy

 Written by:  Mutsumi Kagawa (Chief Global Strategist, Economic Research Institute of Rakuten Securities)



1. As expected, FOMC announced a hawkish shift in monetary policy

In January, the global stocks were hit by corrections. Valuation premium of US stocks are narrowing due to rising bond yields that incorporate the early normalization of US monetary policy, uncertainty about the economic outlook due to the spread of Omicron variant and the escalating tension in Ukraine. Investors are taking more aggressive risk off (avoidance) attitude. Cryptocurrencies such as Bitcoin are forced to into major corrections.

As generally expected by the market, FOMC (Federal Open Market Committee: January 25-26), which was the focus of attention this week, suggested a financial normalization policy;

(1) QE (asset purchase) will end in March

(2) the rate hike will start around March

(3) QT (balance sheet reduction) will be considered after the rate hike

Chart 1 shows the changes of the rate of increase in the PCE core price index (the inflation index that the FRB pays most attention to), the long-term bond interest rate (10-year government bond yield), the short-term bond interest rate (2-year government bond yield) and the policy interest rate (FF target range upper limit) since 1985.

Due to the remark by the FRB official that inflation has risen more than initially expected, it is assumed that short-term bond interest rate will reach 1% and “the interest rate will be raised about 4 times in 2022”. Long-term bond interest rates have also risen to the 1.8% range.

Although inflation was mainly due to rising international commodity prices and supply constraints, the financial authority cannot overlook the increase in inflation and has to expedite with the changes in monetary policy.

<Chart 1: FRB shifted the monetary policy primarily to curb inflation>

(Source) Created by Economic Research Institute of Rakuten Securities, Inc. from Bloomberg  (beginning of 1985 – January 26, 2022)


2. Is it unexpected? Returns of US stocks were strong even in the rate hike phase

Investors are facing the normalization of monetary policy (start of the rate hike cycle). Stocks are likely to continue to move erratically in the near future. However, entering the FRB’s rate hike cycle does not necessarily imply a bear market for US stocks.

Chart 2 verifies “how US stocks performed in the past rate hike cycle” using the S&P 500 index returns (annualized rate of return).

We can see that US stocks were relatively strong (an average annual positive return of about 9%) in a total of 12 rate hikes since 1950. Among the 12 rate hikes, the only one with negative stock returns was in a stagflation environment from 1972 to 1974 (inflation and recession occurred simultaneously).

<Chart 2: Verification of past rate hike cycles and annual returns on US stocks >

(Source) Created by Economic Research Institute of Rakuten Securities, Inc. from Truist Advisory Services/Bloomberg 


The rule of thumb shown in Chart 2 hints that normalization (tightening) of monetary policy will not interfere with the positive movements of stocks for 2022.

However, while the calendar year return of the S&P 500 index was high at +27% last year, this year’s stock returns are only about 10% as a reaction to the limited volatility.

But it is undeniable that it may be more volatile than last year. It can be a concern that concerns from market participants tend to increase during the transitional period of the financial market.

However, there is no change to the current investment strategy, which has set a target of 5000 points for the S&P 500 Index by the end of 2022. The expected return (room for stock price increase) with a view to the end of this year can be higher than the end of last year based on “what goes up must come down (what comes down must go up)”.


3. Asset management strategy to capture inflation trends

Inflation (acceleration of price increase rate), which FRB initially described as “temporary (transitional)” has become apparent, and one of the main factors is the upward trend in international commodity prices.

Chart 3 compares the performances of the S&P GSCI Commodity Index which indicates overall trends in commodity prices, the US Stock Market Index (S&P 500) and the US Bond Index (beginning of 2021=100).

The S&P GSCI Commodity Index is a commodity index developed by Goldman Sachs, calculated and published by S&P Dow Jones, and is known as a Commodity Index that represents the movement of the entire global commodity market.

The index comprises of 24 types of commodity futures from major sectors such as energy centered on crude oil, industrial metals, precious metals, agricultural products and livestock products, and it is a market capitalization weighted index of commodity production in the world.

The index shows a strong trend above last year’s highs, reflecting tight supply and demand and symbolizes the recent acceleration of inflation called “Commodity Driven Inflation”. I would like to focus on the portfolio strategy that incorporates inflation trends based on such “real assets” into asset management.

<Chart 3: Compare performances of commodity prices, global stocks and global bonds>

*It compares the changes in the Commodity Price Index, the US Stock Index (S&P 500) and the US Bond Index since the beginning of 2021.
(Source) Created by Economic Research Institute of Rakuten Securities, Inc. from Bloomberg (beginning of 2021 – January 26, 2022)


The “iShares S&P GSCI Commodity Indexed Fund” (ticker: GSG) introduced in Chart 4 is an US’s exchange traded fund (ETF) that aims to be linked to the above-mentioned commodity index. You can see that its performance is strong against US stocks and bonds.

Investing in the commodity market is called “alternative investment” (one of the investment strategies that replaces traditional assets). By investing in GSG, you can easily diversify into a wide range of commodity markets.

The transaction price per unit of GSG is currently in the USD 18 range, and you can make diversified investments in the commodity market from around 2,000 yen in Japanese currency (as of January 26). It should be noted that this can improve the risk-adjusted returns of overall assets management by incorporating recent inflation-leading commodity market trends into the portfolio.

<Chart 4: Paying attention to the performance of commodity price-linked ETFs>

*It compares the changes in the Commodity Price Index, the US Stock Index (S&P 500) and the US Bond Index since the beginning of 2021.
*The above information is for reference only. It does not recommend any specific investment product.

(Source) Created by Economic Research Institute of Rakuten Securities, Inc. from Bloomberg (beginning of 2021 – January 26, 2022)