Week Ended January 14th, 2022
• Stocks continued lower for the second consecutive week in this New Year, pressured by the fear of the impact that several rates hikes from the Federal Reserve will have on company profitability and therefore valuation. The anticipated moves by the Fed are in response to an out of balance supply/demand equation which has resulted in productions, logistic and labor inflation.
Inflation at the retail level as represented by the Consumer Price Index (CPI) as well as wholesale level as represented by the Producer Price Index (PPI) are rising at unsustainable rates and it is the job of the Open Market Committee of the Federal Reserve (FOMC) to bring down these rates by tightening monetary supply. They will do this with a three-pronged attack. 1) Jawboning inflation lower through comments by Fed Chair Powell along with other Fed officials; 2) reduce or cease their purchase or U.S. Treasury and mortgage backed securities and allow those in existence to mature (roll-off) and 3) raise interest rates. The FOMC will hold a regularly scheduled meeting on January 25-26 and on March 15-16. At this time, we believe the Fed will raise the Federal Funds Rate by 0.25% at the latter.
As noted last week, “at this point we expect a choppy market as the Fed tapers and then begins to raise interest rates. Although this will unsettle the financial markets, if done at an appropriate pace, will ultimately bring back into balance the supply/demand equation and lead to sustainable economic growth.” We would add that during this period expect securities not supported by reasonable valuations to be most affected, but expect those that are growing, but priced reasonably (Growth At A Reasonable Price [GARP]) which can also be defined as those with reasonable fundamental valuations in relation to their rates of projected growth (PE/G) to be affected but also to recover swiftly.
• Several comments illustrate the overall sentiment of the Fed as well as the business community, two of which come from noteworthy individuals.
o On Monday, the Chair and Chief Executive Officer of JP Morgan Chase, Jamie Dimon observed that in his opinion, “the consumer balance sheet has never been in better shape. They’re spending 25% more than in pre-COVID. Their debt to service ratio is better than it’s been since we’ve been keeping records for fifty years.”
In regard to the potential for Fed action, Dimon stated that “it’s possible that inflation is worse than they think and they raise rates more than people think. I personally would be surprised if it’s just four increases.”
o During an interview on CNBC this past Thursday, Patrick Harker, President and CEO of the Philadelphia Federal Reserve noted that the Fed does “need to take action on inflation. It is more persistent than we thought a while ago” and added that “I think it’s appropriate to take action this year. Three is what I’ve penciled in, but four is not out of the question in my mind.”
• The Fed must tread carefully to not tighten too quickly so as to spook investors or not be perceived to be behind the curve either, all the while dealing with the various COVID related variants that may impact the balance between demand and supply. Not an easy task.
• Despite all of the handwringing regarding inflation and interest rates, the bond market was relatively calm this week. The curve flattened with the yield on the two-year U.S. Treasury Note rising from 0.87% to 0.99% whereas the yield on the ten-year rose by only 0.02% to 1.78% from 1.76% one week prior. The net result was a compression of the difference between those two yields (10-year as compared to 2-year) to 0.79% from 0.89%.
• You may read that the NASDAQ Composite is off to its worst start since 2016. Although that is accurate it is also important to note that this index ended up 7.50% during that calendar year, a return that lagged the S&P 500, which closed up 9.54%. All major averages finished well in the black during 2016.
• Sentiment readings, a contrarian indicator, are at relatively low levels with those responding that they are bullish coming in at 24.9% of respondents as compared to bears at 38.3% and those that are neutral on the market at 36.8%, respectively.
• The Russell 2000, a mid-cap index comprised of the second and third thousand largest public traded American companies has had a tough time over the past year, lagging the broader and large cap indices by a wide margin.
• Oil & Gas and Telecom stocks have led the market for the first two weeks of this trading year, odd bedfellows, but something to keep an eye on as investors are “bar-belling” the potential for continued high energy prices, historically a sign of better economic times ahead with high dividend payers, a sign of slowing economic growth.
• Although still very low on an historical basis, mortgage rates continue to rise.
• Patience is paramount during times of market transition. Let’s see how this plays out a bit. Keep your eye on the long-term objective. Don’t be swayed by short-term volatility.
• As noted within this report one week ago, “the market capitalization of Apple Computer (AAPL) briefly exceeded the $3 trillion market before selling off to a market cap of $2.825 trillion. The rise in the share price of Apple has been a result of rising earnings, their ability to generate free cash flow and share buybacks. Apple, like many tech companies may face choppy trading over the next several months. However, these tailwinds noted above along with a convincing secular growth story should help put a floor under shares as well as set it up for stronger trading during the second half of 2022 and into 2023. This can also be said for other tech stalwarts, namely Microsoft (MSFT), Alphabet (GOOGL) and NVidia (NVDA).”
• There were several key statements from the text of the Fed minutes, to include:
o “Almost all participants agreed that it would likely be appropriate to initiate balance sheet runoff at some point after the first increase in the target range for the federal funds rate.”
o “Many participants judged that the appropriate pace of balance sheet runoff would likely be faster than it was during the previous normalization episode.”
o “Participants remarked that inflation readings had been higher and were more persistent than previously anticipated.”
• There are two key releases regarding the health of the housing market this upcoming week. On Wednesday, December Housing Starts and on Thursday, in addition to the Weekly Report on Initial Claims for Unemployment Benefits, there is December Existing Home Sales.
• The corporate earnings season is upon us and kicking into full swing. Some potentially market moving companies reporting include – Charles Schwab (SCHW), Goldman Sachs (GS), Bank of New York Mellon (BK), Morgan Stanley (MS), US Bancorp (USB), UnitedHealth Group (UNH), Bank of America (BAC), Procter & Gamble (PG), Kinder Morgan (KMI), Travelers Companies (TRV), Netflix (NFLX), Intuitive Surgical (ISRG), Union Pacific (UNP), CSX Corp (CSX) and Schlumberger (SLB).