U.S. and International Equities
Equities lost ground in January after a strong 2021. Increased COVID-19 cases, inflation concerns, and the Federal Reserve’s (Fed) recent hawkish sentiment were major themes in investor’s minds. Moreover, disappointing outlooks from some widely followed tech companies amid relatively high growth equity valuations put downward pressure on stock prices.
Developed international market (MSCI EAFE) and emerging market (MSCI EM) stocks also pulled back in January. High COVID-19 variant cases worldwide affected economic growth and played a role in tepid international market returns. Emerging markets were a relative bright spot in January after lagging last year on the back of concerns over Chinese regulation and real estate indebtedness.
Most sectors lost ground in January reversing much of December’s gains. The major bright spot was the energy sector, which returned almost 20% for the month. The sector continues to ride on the back of higher oil and gas prices.
Both natural gas and oil had an outstanding January, gaining over 30% and 17%, respectively on the back of higher demand, improving economic conditions, and fears of supply disruptions from a potential Russia-Ukraine conflict. Despite inflation concerns, the major metals, gold, silver, and copper, lost ground to begin the New Year, following a difficult 2021.
Fixed Income Begins the New Year Lower
The benchmark Bloomberg U.S. Aggregate Index finished January lower following a down year during 2021. Market participants sold off bonds in light of the Federal Reserve’s (Fed) hawkish sentiment in the face of high inflation. High yield bonds (Bloomberg High Yield Index), which were a bright spot in the fixed income space during 2021 were not spared in January. Both developed international bonds (Citigroup World Government Bond Index) and emerging market bonds (JP Morgan Emerging Markets Global Bond Index) also lost ground to begin 2022.
“Investors are certainly not used to the selling pressure we witnessed in January, yet bouts of such activity are not abnormal when we consider history,” explained LPL Research Senior Vice President and Director of Research Marc Zabicki. “While periods of volatility are likely not over for 2022, this market does look a bit oversold to us at present.”
U.S. Economic Data Recap
Inflation: Overall, consumer prices increased for the ninth straight month in December. The headline Consumer Price Index (CPI) increased at its fastest pace since June 1982. The growth in CPI came in 7% on a year-to-year basis which was in-line with what analysts expected. Removing volatile food and energy prices, the Core Consumer Price Index increased by 5.5% on a year-to-year basis and more than what economists’ expected.
The Producer Price Index (PPI) increased as supply constraints lingered, leading to one of its largest annual gains since the series was updated over 10 years ago. For the 12 months through December, PPI increased over 9.5%, which came in slightly lower than economists expected. Core PPI, excluding food, energy, and trade services, increased almost 7% year-over-year.
U.S. consumer: The Conference Board’s Consumer Confidence Index dipped in January as consumers planning to make major purchases became less optimistic about business conditions in the short term amid increased COVID-19 cases. Nevertheless the index came in well off the pandemic lows. The survey also showed that even with relatively high inflation conditions, more consumers expect to buy big-ticket items over the next six months.
The University of Michigan consumer sentiment survey dropped 2.5% in January from December to over 68.The reading now stands at its second-lowest level in a decade as many Americans remain concerned about rising prices across many consumer markets.
Retail sales: After increasing for the fourth straight month in November, retail sales declined almost 2% in December on a month-to-month basis. An increase in Covid-19 Omicron variant cases along with inflation appear to be weighing in on consumer behavior. Sales at retail stores, online stores, and restaurants declined by almost 2%, infusing the end of the holiday shopping season. On a year-over-year basis, December retail sales rose over 16%.
U.S. home sales: December home sales declined over 7% year-over-year. That being said, full-year 2021 sales came in over 8% higher than 2020. The COVID-19 pandemic, where work from home became an option, along with demographic changes with millennials purchasing homes contributed to the year-over-year increase. Less than 1 million homes were available for sale at the end of December, which contributed to weak December home sales. The median existing home sale price in November came in just over $358,000, more than 15% above December 2020 levels.
Small business sentiment: The National Federation of Independent Business (NFIB) Small Business Optimism Index increased slightly in December compared to November as small business owners remained pessimistic concerning short-term business conditions. Unfilled job openings remain an issue. Over 20% of owners said inflation was the single most important problem for operations, which was an increase from 18% in November. On a positive note, price increases among small businesses showed a decline in December compared to November.
Federal Reserve (Fed) news: The Federal Reserve (Fed) ended its two-day Federal Open Market Committee (FOMC) January meeting echoing its hawkish shift that began in December. Chairman Powell confirmed that the FOMC is “of mind to raise rates at the March meeting” and the Committee believes there is ample room to increase rates “without threatening the labor market”. While most of the details were consistent with market expectations, there were some details that implied the Fed may move faster than expected.
U.S. employment: At the end of December, the U.S. unemployment rate has declined substantially from last year’s peak to under 4%. That being said, the labor force participation rate is just below its long term average near 62%. Even though some statistics like the labor force participation rate remain far from ideal, the labor market landscape remains tight. This endorses the view taken by the Fed that the labor market is healthy enough to warrant a more hawkish view.
The economic recovery has continued even as the battle against COVID-19 and its variants continues. Strong earnings were an important driver of 2021’s strong stock market performance. Companies’ ability to successfully absorb higher input costs and pass them onto their consumers will play an important role in future earnings results and also the equity markets amid persistent supply chain challenges.
Inflation is proving stickier than many anticipated. The Fed’s hawkish view affirms this. As interest rates have increased given the Fed’s sentiment, equity valuations were discounted in January, sending prices lower. Moreover, fourth quarter earnings growth prospects have picked up after a mixed start to the reporting season, which could be a positive for equities moving forward.
In addition, inflation should begin to stabilize once the economy completes its reopening, when supply chains are fully operational, and labor shortages ease. The mitigation of COVID-19 variants worldwide and containment of the Omicron variant, will continue to be critical factors in determining the economy’s trajectory for 2022. In our view, the health of the consumer should continue be an important driver for the economy and corporate profits in 2022.
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