There hasn’t been much divergence from the major themes we’ve been monitoring for many weeks now. The market’s focus remains fixed on inflation, the Federal Reserve’s policy schedule and omicron. These three factors are interlinked, and developments on one front will impact the forecast on the other two. Therefore, nothing has altered our 2022 outlook, and we invite you to read our Q4 Market Commentary, “The Long and Winding Road That Leads to Normal,” which spells out our view in far greater depth.
In a nutshell (from the commentary):
“At long last we believe 2022 will mark the beginning of a return to pre-COVID-19 conditions. We expect economic growth will remain strong and above intermediate- to long-term trends but don’t expect the torrid pace of growth set in 2021. Inflation, too, will hover above its historical trend but, notably, will pull back from today’s elevated levels (even following December’s read). Monetary and fiscal policy will remain accommodative but pared back from the emergency measures implemented over the past two years. Lastly, earnings growth will moderate but prove to be enough for the stock market to climb higher. Cyclical and economically sensitive sectors and value stocks will stand to benefit most, particularly in the first half of 2022.”
We have seen a continuation of a sharp rotation away from stocks valued on sales and future growth and into companies with profit, cash flows and lower valuations — those cyclical, economically sensitive and value sectors we just described. Value stocks and small-cap stocks have done well thus far, while momentum and “meme” stocks have been walloped, with some down more than 50 percent from recent highs.
We’ll dig into the data throughout the year in this weekly commentary. And as we move through 2022, volatility is likely as Fed policy, omicron and inflation narratives resolve (all else being equal). Markets and the economy will make progress in 2022, but we expect some stop-and-go traffic on the road ahead. Now, to the week that was and the week that’s ahead.
Wall Street Wrap
Inflation Catches the Spotlight Again: The Consumer Price Index once again grabbed the lion’s share of headlines on the week after rising 7 percent year over year in December. That’s the highest annual increase since 1982, but it was largely expected by analysts. Now, the month-over-month measure rose 0.5 percent, seasonally adjusted, after a 0.8 percent increase in November. Core CPI, which strips more volatile components like fuel and food, was up 5.5 percent on the year and 0.6 percent over the prior month. From another angle, the producer price index, which measures wholesale costs before they reach consumers, rose 9.7 percent in December. But, again, the month-over-month tally was more subdued, rising just 0.2 percent in December, compared to a revised increase of 1 percent in November.
While we witnessed multi-decade highs for price gains once again, we didn’t see a pointed reaction in markets. The report didn’t contain any surprises, and those month-over-month reads indicate inflation may be peaking. Recent reports beyond CPI contained some evidence that inflation is downshifting. The ISM Manufacturing and Services indices two weeks ago showed delivery times were improving. The Baltic Dry Index — which tracks the costs of shipping raw materials by sea — has fallen from its peak. Omicron is causing some headaches with absences and at the ports, but we’re confident this should dissipate.
We’ll be keeping a close eye on prices going forward; we’ll remain patient on this front, as we expect it’ll take a quarter or two to really see prices approach a lower, longer-term trend. We think that trend line will be above the Fed’s target inflation rate of 2 percent, perhaps closer to 3 percent.
Retail Sales Notch December Decline: Retail ended the year in anticlimactic fashion, declining 1.9 from the previous month. Omicron, inflation, supply chain disruptions and consumers pulling holiday purchases earlier into October and November yielded a bit of a mess in what some are calling a “disappointing” report. We’re taking December’s read with a huge grain of salt.
Sales still rose a healthy 16.9 percent above December 2020 levels, after seasonal adjustments. We remind that consumer balance sheets and savings levels are still quite healthy, which means they still have spending power. December’s report isn’t some harbinger of something worse.
As we move through 2022, we expect consumers to shift a share of spending away from goods and back to services, especially as omicron retreats and more dollars funnel to leisure, travel and restaurants. Reduced spending on goods could help supply chains catch up and release some of the upward pressure on prices.
Inflation Worries Persist in January: Consumer sentiment fell to its second lowest level in a decade as inflation worries and skepticism about economic policy weighed on people’s outlooks. The University of Michigan Consumer Sentiment Survey came in at 68.2 in January, down from 70.6 the month prior. We think the Fed has pivoted and is going on a PR blitz about inflation to help allay some of these concerns and tamper expectations that red-hot inflation is becoming embedded, or permanent.
Fed Chairman Settles Markets: Ultimately, the inflation discussion all boils down to what the Fed is going to do. Fed Chairman Jerome Powell appeared before the U.S. Senate Tuesday for his nomination hearing and provided clarity that markets appreciated. Powell said he will focus on keeping inflation from becoming entrenched, and he still attributes elevated prices to pandemic-related supply chain disruptions. A monetary policy alone isn’t going to unclog those supply chains, but the Fed can’t exactly ignore inflation at this point.
Still, if we take Powell at his word (and he’s proven to be quite reliable), the Fed isn’t going to bludgeon inflation. Rather, we think the Fed’s accelerated tapering/interest rate timeline is simply fine-tuning the approach. All policy measures will be implemented with an eye on extending the business cycle, which means we don’t expect an aggressive overcorrection. Powell articulated the connection between inflation and employment, as they don’t exist independent of one another. As part of its employment mandate, the Fed must prevent extended periods of excess inflation. To maximize employment, policy should aim to extend the business cycle.
What’s more, the Fed may be getting three new members who skew to the dovish side and will shape policy in a way that maximizes employment across all demographics. In other words, don’t anticipate a Paul Volcker-esque brawl.
The Week Ahead
A shortened week of trading will also be a bit lighter on hard economic data, though corporate earnings season is heating up:
- Tuesday: The Empire State regional manufacturing index hits a market open, and we’ll be monitoring data for any signals that pricing pressures are abating. The NAHB home builders index, a gauge of builder confidence, is also due. That’s expected to come in around the 80s, much as it has for many months. Charles Schwab and Goldman Sachs are among notable companies reporting earnings.
- Wednesday: We’ll get more housing data, from building permits to housing starts. Bank of America, US Bancorp, Procter & Gamble, Intel, UnitedHealth Group and Morgan Stanley are notable earnings reports.
- Thursday: Existing home sales is the most notable data release, and we’ll get another key regional manufacturing report from the Philadelphia Fed. American Airlines, CSX Corp., Union Pacific Corp., Intuitive Surgical and Netflix are among 43 companies reporting earnings.
- Friday: We’ll get a comprehensive view of the economy’s trajectory with the Leading Economic Indicators index. Ally Financial, IHS Markit and Schlumberger NV will report earnings to close the week.
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