This article first appeared in the Telegraph.

Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

FEW of us mourn the passing of January. It can be a depressing month with few redeeming features.

One of these has been that the performance of markets in the first month of the year is usually a bit better than in the other eleven months. No one really knows why. Not in 2022, however. Not only has this been one of the minority of years (about 30%) in which shares have fallen in January. It’s also been one of the worst ever starts, with only a late run in the final couple of trading days preventing a double-digit decline for the S&P 500.

The tendency for shares to rise at the start of the year is one of the so-called January effects. Another is the way in which the performance of markets in the first month sets the tone for the rest of the year. Not always, and not often enough, or predictably enough, to be useful. But there does seem to be a correlation. On the face of it, that’s not encouraging as we peer into the rest of 2022.

Maybe, however, we should take comfort from the force of January’s U-turn. Perhaps, the retreat we’ve experienced since the start of the year has already let enough air out of the balloon. Maybe a more hawkish Fed has shaken investors out of their complacency and provided the pause that refreshes? Maybe. I think we probably have had the worst of the correction. But I don’t expect 2022 will be a year that we’ll remember fondly. Here’s why.

Financial conditions are more constrained than they were but are still too easy. They are nowhere near the level at which the Federal Reserve would reconsider its tightening plans. It’s early days in the new restrictive regime so the policy backdrop will remain a headwind for the foreseeable future. Jay Powell isn’t about to blink.

On the other hand, the market is certainly looking a tad oversold in the short term. The proportion of stocks trading above their 50-day average is at its lowest since the start of the pandemic two years ago. Just 17% of shares are higher than this key support. Momentum rarely stays this poor for long.

There has also been a very significant de-rating of stock market valuations. A year ago, leading US shares traded at around 24 times their expected earnings. Today that multiple is just 19. That process has been underway for quite some time below the surface. Strip out the performance of a handful of high-flying growth stocks and the rest of the market has been re-assessing the outlook for a good 12 months now.

This is exactly what we should expect. The Federal Reserve’s zero interest rate policy and quantitative easing programme kept bond yields around a percentage point lower than they would otherwise have been. And that in turn has enabled shares to trade on a higher multiple of earnings than would normally have been the case. Turning off the Fed’s liquidity taps has put that into reverse, exactly what could have been predicted. The market’s response last month was entirely rational.

And that is why I would not anticipate a rapid rebound from today’s more subdued market level. Valuations have retreated to a more sensible level, so the onus is now on earnings to keep markets moving forward. The current expectation is for earnings to rise by about 8% this year. That’s less than we hoped for a month ago but not by a huge margin. With around a third of the S&P 500 having reported so far in the fourth quarter earnings season, most have modestly beaten expectations. We’re on track. Earnings are holding up.

For shares to keep their head above water this year, those profits need to keep being delivered. Two other things will also be required. The first is that the Fed succeeds in walking the policy tightrope, raising rates by just enough to keep inflation in check but by no more than is absolutely necessary. An overly aggressive policy mistake is rightly top of the list of investors’ concerns.

The second is harder to predict by its very nature. We need to avoid any nasty geopolitical surprises. It is not clear what the West’s reaction would be to a Russian invasion of Ukraine, nor what the subsequent market reaction would be. But it’s hard to imagine that an already nervous market would respond positively.

So, it’s going to be harder work this year. How can investors navigate the choppier waters ahead? Looking back 20 years to the last major unwinding of a technology bubble, there was actually no shortage of investment opportunities. Back then they were in the form of high-yielding ‘old economy’ stocks, businesses that investors wrongly thought had no future in an internet-enabled world. The reality was different. As the bubble deflated, the 6-7% dividend yields of companies like Boots and Whitbread suddenly seemed rather attractive.

One sector that has underperformed significantly in recent years is utilities. That’s not surprising. Defensive stocks that rise and fall less than the market as a whole tend to lag when shares are rising strongly. However, these unfashionable stocks are as far below trend as they were in 1999 after which they outperformed massively for a two-year period as the bubble burst. It doesn’t feel like we are facing a repeat of that painful market decline. But in relative terms, I wouldn’t be surprised if 2022 turns out to be another year in which the ugly ducklings start to look like swans.

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Overseas investments will be affected by movements in currency exchange rates. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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