Market Commentary - January 2022

Monthly Update

After an amazing market run during 2021, 2022 has started out on a much bumpier path. While the S&P 500 was lower by 5.3% for the month of January, most of the damage was done in tech and biotech stocks -reflected by a NASDAQ index sell-off of 9%[1]. The Russell 2000 index, where about one third of the components don’t make money, was weaker by 9.7%[2]. The catalyst for much of the volatility was having reality set in that we are now entering a new investing environment. The Federal Reserve and many other central banks are now tightening monetary policy in response to both inflation and to reverse their covid emergency stance.

The adjustment was also noteworthy in US Treasuries where the 2 yr note yield jumped to 1.18% from .73% at 2021 year end[3]. That is a rather sharp increase and is based on the increased Fed rate hike expectations that are now being priced in. As of this writing, the fed funds futures market is pricing in about a 70% chance of 5 rate increases this year off the 0-.25% current range[4]. This at the same time the expansion of the Fed’s balance sheet will stop in March and could at some point begin to shrink in a process referred to as quantitative tightening. Call that double tightening if it occurs.

One of the main triggers for the rate moves and expected Fed response, was the 7% increase in the US consumer price index for December. One has to go back to 1982 to see a faster rate. The longer end of the US Treasury market has also begun to adjust, as the 10 yr yield in December rose 27 basis points to 1.78%, the highest since March 2021[5].

The rate move was also notable outside the US as the German 10 yr bund yield got back to zero for the first time since May 2019. Inflation is rising in the Euro region as well, as Germany saw its CPI rise 5.1% in January[6]. The European Central Bank still has interest rates well below zero and are still conducting large scale asset purchases. The Reserve Bank of Australia announced the end of its QE program on February 1^st and the Australian 10 yr yield was higher by 23 basis points in December to 1.90%, a one year high.

As for international stock markets, Europe has outperformed with a slight gain in the UK and modest losses in German and France. In Asia, it’s been mixed as indices in Japan, mainland China, South Korea and Australia were weak while have rallied so far this year in Hong Kong, India, Singapore, Thailand, Indonesia and the Philippines.

Inflation and the Central Bank Response

To elaborate further on the points above, the current bout of inflation is a global phenomenon where higher commodity prices, strained supply chains and lofty transportation costs are widespread. In the US and some other countries, we are also seeing faster wage gains but where the increases are still not keeping up with the rise in inflation.

I laid out what the Fed is about to do but the ECB will end their emergency purchase program in March. The Bank of England, after raising interest rates in December will again do so in February and the Bank of Canada will increase its benchmark rate in March. The Monetary Authority of Singapore tightened its FX exchange policy in December which is their way of altering monetary policy. We also expect to see a continuation of rate hikes coming from emerging market central banks this year.

Thus, after a few years of extraordinary easing where the world’s central banks went to war against the impact of covid, that so called ‘punch bowl’ is now being taken away. In a world that has feasted on low inflation and very low interest rates that has led to much higher debt levels and rich market valuations, an indigestion period is upon us.

I do believe that the rate of change with inflation will start to moderate in coming months but mostly in response to tougher comparisons. Also, I do expect the intense supply chain pressures to begin to ease in coming quarters and there are early signs of it. This said though, I think that inflation will remain sticky this year and maybe next year for a few reasons. Labor costs are rising at the quickest pace in decades. As of the fourth quarter, the Employment Cost Index from the government showed a 5% year over year increase in private sector wages and salaries, the most in decades. Companies experiencing this higher cost, which is the biggest on the income statement, will do their best to enhance productivity and cut costs but most will also raise prices too in order to recapture any lost profit margins.

Also, higher rent costs will continue to flow through the inflation statistics this year and companies will continue to raise prices as they try to cover the spike in other costs like materials, transportation in addition to labor. This means from a policy standpoint that the Fed will continue with their monetary tightening.

Stocks and Bonds

I would define the equity market sell-off year to date as a valuation rethink that really started last year for many highly valued equities. Keep in mind that there are two main drivers of stock prices, the direction and pace of earnings growth and also the multiple that is placed on it. Right now, that P/E multiple, or whatever multiple one uses, is contracting. The question then is how does the earnings story play out this year in the context of a moderating economy, growing costs and higher interest rates.

I have my eyes closely watching the corporate bond market for hints at which investors become worried about economic growth, particularly the high yield market as investment grade will more track interest rates. High yield companies of course need a healthy economy in order to generate the cash flows to service their debt and also grow. The yield to worst (earliest call date) in high yield for the Bloomberg High Yield Index in January rose to 5.27% from 4.21% at year end[7]. The spread to Treasuries widened out to 339 basis points from 283 basis points on December 31^st. These figures are still below where they were pre Covid so no cause for concern yet but something to watch.

The Economy

The US economy grew by 6.9% in the fourth quarter but 490 basis points of that growth was due to inventory building which will reverse in the 1^st quarter and why the Atlanta Fed is estimating zero growth in Q1[8]. Higher inflation, the impact of omicron, a shrinking US budget deficit and now higher interest rates will all impact growth too. Internationally, I’m hopeful that after the winter Olympics the Chinese government will shift away from its zero covid policy and begin to understand the need to live with it. A full reopening of their economy and in the rest of Asia would be a large boon for global growth. Germany in particular would benefit greatly from a stronger Chinese economy.

The Chinese economy though will be dealing with its own economic challenges this year as the residential real estate development market slows down dramatically. But, with a very high savings rate north of 30%, I’m hopeful that the Chinese consumer will be able to power through. All in though, we expect it will be a choppy year as while we hope we can rid ourselves of covid in terms of being a dominant force in our lives, there will be other factors that mitigate the benefits.

Oil Prices

Also worth noting about January was the 17.8% rise in oil prices after a 14% jump in December. At around $88 per barrel for WTI, it is at the highest level since 2014[9]. The bigger picture reason for the rally is modest supply growth, a long term lack of investment and demand that is about back to where it was pre covid. But, we also had worries about supply out of Russia if they are sanctioned heavily in response to any invasion into Ukraine. Because of our dependency on that supply however, I do think that sector will avoid sanctions. Gasoline prices at the pump in response to the higher oil price rose to just below the highest since 2014 according to AAA. Unless demand falters notably, I don’t see any relief from the supply side any time soon and expect elevated energy prices for a while to come.

Conclusion

As stated in the beginning of this piece, we are entering a more challenging investing environment for all the reasons stated and our return expectations should be tempered as a result. This is not the end of the world of course, because we are coming off a string of some very good years but I think a reality check is always the most productive way to approach things.

Either way, whatever the outcome will be, it remains vital that investors have a plan that suits their short term liquidity needs over the next 2-3 years. Knowing that period of time is covered can help separate the balance of one’s portfolio from what I believe will continue to be a choppy time for the economy and markets. Please do not hesitate to reach out at any time with questions or for any discussion on the economy and these markets.

Disclaimer

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The market and economic data is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The information in this report has been prepared from data believed to be reliable, but no representation is being made as to its accuracy and completeness.

Nothing in this material should be construed as investment advice offered by Bleakley Financial Group, LLC or Peter Boockvar. This market commentary is for informational purposes only and is not meant to constitute a recommendation of any particular investment, security, portfolio of securities, transaction or investment strategy. No chart, graph, or other figure provided should be used to determine which securities to buy, sell or hold. No representation is made concerning the appropriateness of any particular investment, security, portfolio of securities, transaction or investment strategy. You should speak with your own financial professional before making any investment decisions.

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Treasury inflation-protected securities (TIPS) help eliminate inflation risk to your portfolio as the principal is adjusted semiannually for inflation based on the Consumer Price Index – while providing a real rate of return guaranteed by the U.S. Government.

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