Investors brace for more market tumult as interest rates keep rising

The central bank has raised interest rates to the highest levels since 2007, stoking mammoth swings across global markets and a steep selloff in assets from stocks and bonds to cryptocurrencies. The tumult that erased more than $12 trillion in value from the U.S. stock market—the largest such drawdown since at least 2001—is expected to continue as rates keep rising.

Analysts at some of the biggest U.S. banks expect the stock market to retest its 2022 lows in the first half of the new year before beginning to rebound. Those at Goldman Sachs expect the S&P 500 to end 2023 at 4000, about a 4% rise from where it ended 2022.

The volatility has been especially punishing for the market’s behemoths. Five big technology stocks accounted for about a quarter of the U.S. stock market’s total declines last year, a bruising selloff reminiscent of the dot-com bust two decades ago.

The S&P 500 ended the year down 19% after the conditions evaporated that had paved the way for years of a nearly uninterrupted stock-market rally and a run in some of the most speculative bets.

Cryptocurrencies tumbled, splashy initial public offerings all but came to a halt and blank-check companies imploded to end the year, a stunning reversal of the mania that swept markets in the previous two years.

“We are in a world where interest rates exist again,” said Ben Inker, co-head of asset allocation at Boston money manager GMO, which oversees $55 billion in assets.

One of the biggest flip-flops occurred under the market’s surface. Investors abandoned the flashy tech and growth stocks that had propelled that market’s gains over the previous decade.

And value stocks—traditionally defined as those that trade at a low multiple of their book value, or net worth—staged a revival after years of lackluster returns.

The Russell 3000 Value index outperformed the Russell 3000 Growth index by almost 20 percentage points, its largest margin in Dow Jones Market Data records going back to 2001.

Now, Mr. Inker and other investors—hunting for opportunities after an abysmal year for both stocks and bonds—say it is just the beginning of a big stock-market rotation.

Money managers say they are positioning for an environment that bears little resemblance to the one to which many grew accustomed after the last financial crisis. The era of ultralow bond yields, mild inflation and accommodative Fed policy has ended, they say, likely recalibrating the market’s winners and losers for years to come.

“A number of investors were trying to justify nosebleed valuation levels,” said John Linehan, a portfolio manager at T. Rowe Price. Now, “leadership going forward is going to be more diverse.”

The Fed is set to keep raising interest rates and has indicated that it plans to keep them elevated through the end of 2023. Many economists forecast a recession ahead, while Wall Street remains fixated on whether inflation will recede after repeatedly underestimating its staying power.

Mr. Linehan said he expects the run in value stocks to continue and sees opportunities in shares of financial companies, thanks to higher interest rates. Others say energy stocks’ stellar run isn’t over just yet. Energy stocks within the S&P 500 gained 59% last year, their best stretch in history.

Some investors are positioning for bond yields to keep rising, potentially dealing a bigger blow to tech shares. Those stocks are especially vulnerable to higher rates because in many cases they are expected to earn outsize profits years down the road, a vulnerability in a world that values safe returns now.

The yield on the 10-year Treasury note ended 2022 at 3.826%, the biggest one-year increase in yields since at least 1977, while bond prices tumbled. From risky corporate bonds to safer municipal debt, yields rose to some of their highest levels of the past decade, giving investors more choices for parking their cash.

“I don’t think this next decade is going to be led by technology,” said Mark Luschini, chief investment strategist at Janney Montgomery Scott. “This one-size-fits-all notion that you just buy a broad technology index or the Nasdaq-100 has changed.”

The tech-heavy Nasdaq-100 index lost 33% in 2022, underperforming the broader S&P 500 by the widest margin since 2002.

Investors yanked about $18 billion from mutual and exchange-traded funds tracking tech through November, on track for the biggest annual outflows on record in Morningstar Direct data going back to 1993. Funds tracking growth stocks recorded $94 billion in outflows, the most since 2016.

Meanwhile, investors have taken to bargain-hunting in the stock market, piling into value funds. Such funds recorded more than $30 billion of inflows, drawing money for the second consecutive year.

“Profitability and free cash flow are going to be very important” in the coming year, said Tiffany Wade, senior portfolio manager at Columbia Threadneedle Investments.

Ms. Wade said she expects the Fed to be more aggressive than many investors currently forecast, leading to another rocky year. If the Fed puts a pause on raising interest rates over the next year, she thinks growth stocks might see a bounce.

Other investors are heeding lessons from the years following the bursting of the tech bubble, when value stocks outperformed their growth counterparts.

Even after last year’s bruising declines, the technology sector trades at a wide premium to the S&P 500. Stocks in the energy, financial, materials and telecommunications sectors still appear cheap compared with the broader benchmark, according to Bespoke Investment Group data going back to 2010.

Plus, big technology companies face stiffer competition and potentially tougher regulation, a setup that may disappoint investors who have developed lofty expectations for the group.

Their run of impressive sales growth will likely sputter as well, Goldman Sachs analysts said in a recent note. Aggregate sales growth for megacap technology stocks is forecast to have risen 8% in 2022, below the 13% growth for the broader index.

“I just don’t think the prior regime’s winners are going to be tomorrow’s winners,” said Eddie Perkin, chief investment officer of Eaton Vance Equity. “They’re still too expensive.”