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The January effect — a tendency for stock prices to rise at the start of the year — is at it again, as both the Dow Jones and S&P 500 reached new intraday records on Tuesday.
Yet trouble is looming just over the horizon, says Mohamed El-Erian, president of Queens’ College, Cambridge University, and chief economic advisor at Allianz SE.
In a recent interview with Bloomberg, the economist highlights a “trifecta” of risks facing the U.S. economy going into 2022.
“Who would have guessed that you would have inflation at 6.8%, you’d have the 10-year at around 150, and you would have 70 record highs on the S&P?” he asks.
Here’s what those three risk factors mean for investors and how you might hedge against them — including one exotic asset you probably haven’t considered.
Spiking inflation
Inflation erodes our purchasing power. If you’re holding cash, you won’t be able to purchase the same amount of goods and services as before.
And as El-Erian points out, November saw a 6.8% year-over-year increase in the consumer price index — the biggest spike since 1982.
You can try to protect yourself in a few different ways.
Some stock market sectors tend to do well in an inflationary environment. Energy stocks, for instance, have made a strong comeback: In the past year, Chevron surged 41%, ExxonMobil rose 54%, while ConocoPhillips shares shot up a whopping 83%.
Other investors prefer to stick with traditional inflation hedges like gold and silver, which can’t be printed out of thin air like fiat money.
Meanwhile, more and more people are calling Bitcoin the new gold. Investors can either buy bitcoins directly or get exposure through companies that have tied themselves to the crypto market, such as Coinbase Global, MicroStrategy and Tesla.
Rising interest rates
Jerome Powell, chairman of the Federal Reserve
The days of cheap borrowing seem to be coming to an end, as the Fed has hinted at multiple rate hikes in 2022 to combat inflation. El-Erian worries that the economy won’t be able to handle it.
“A system conditioned by more than a decade of floored interest rates and ample liquidity would quickly prove unable to tolerate higher rates,” he wrote in a Financial Times column earlier this week.
At the end of December, El-Erian pointed out that the U.S. 10-year Treasury note was yielding 1.50%. A week later, the yield has already gone up to 1.73%.
Still, while many market participants fear higher interest rates, some financial companies — especially banks — look forward to them. Banks lend money at higher rates than they borrow with, pocketing the difference. As interest rates increase, the spread earned by banks widens.