January 2022 | Equity Commentary
Published on February 8th, 2022
Financial markets have been choppy to start the new year. The S&P 500 reached an all-time high on January 3, but the index has experienced pronounced volatility since. Concerns over rising interest rates, persistent inflation, and geopolitical tensions between Russia and Ukraine were likely what drove the index into correction territory mid-day on January 24. Volatility moves stocks in both directions, however, and the index finished January down a meaningful but not alarming 5.3%. Bond markets were not insulated from the selling pressure either, as yields on long duration U.S. Treasuries marched higher throughout the month.
The U.S. economy posted a strong 6.9% annualized growth rate in Q4 2021. Strength in Q4 capped off the strongest year of economic growth in the U.S. in almost 40 years, with output growing by 5.5%. To be fair, however, a significant driver of the strong Q4 GDP was due to companies replenishing inventories. Without the inventory restock, GDP would have grown at a much more modest 1.9% in Q4.1
Activity in the U.S. jobs market continues to surprise to the upside. From December to January, nonfarm employment rose by 467,000, which was over three times Wall Street estimates.2 The unemployment rate rose to 4% from 3.9%, as approximately 1.2 million new people entered the labor force. The Bureau of Labor Statistics also reported that December and November’s jobs numbers were significantly understated December was revised from 199,000 to 510,000, and November was changed from 249,000 to 647,000.2 Much like the GDP figures cited above, the jobs numbers clearly indicate that Omicron did not create a major disruption to economic momentum.
In 2021, U.S. home sales hit a 15-year high, with homes selling at their fastest pace in history.3 According to data from the National Association of Realtors, existing-home sales rose 8.5% in 2021 from a year earlier. These trends have spurred homebuilders to ramp-up construction, leading to their most active year since the housing bubble burst in 2006. In December, the number of housing units under construction was the highest it’s been since 1973.3 However, many homebuilders are starting construction on more homes than they are finishing, underscoring some of the issues with labor and materials shortages.
The Consumer Price Index for all urban consumers rose 0.5% in December (seasonally adjusted), putting inflation’s full year increase at 7% and marking the biggest jump in over 20 years. Wages are also on the rise, as the U.S. employment-cost index rose 4% in Q4 2021 from a year earlier, which was also the biggest jump in 20+ years.4 Higher wages are something of a double-edged sword in an inflationary environment. Rising wages can neutralize the effect of higher prices for goods and services, but they can also compel businesses to raise prices to account for the higher cost of labor.
The Federal Reserve appears to have turned hawkish on the inflation issue, and January market volatility may reflect uncertainty over how frequently, and by how much, the Federal Reserve plans to lift the fed funds rate. In Chairman Powell’s words, “It isn’t possible to sit here today and tell you with any confidence what the precise path [of the fed funds rate] will be.” This level of ambiguity is a departure from Federal Reserve guidance over the last twenty years, which sought to assure market participants of “gradual increases.” Investors could rely on quarter point rate increases at every meeting or every other meeting. In the current environment, the Federal Reserve is offering no timeline and no real guidance, which has been unsettling for the equity markets.
We believe that another reason for uncertainty in the markets is the sheer range of possibilities when it comes to inflation, interest rates, and the pandemic in 2022. Inflation may persist all year, which could trigger a rate increase of a quarter percentage point or more at all seven Federal Reserve meetings. Alternately, inflation could subside later in the year as supply chain issues are resolved and consumers shift spending to services, which may lead to fewer rate cuts during the year. The pandemic, as ever, is a wildcard. Myriad potential outcomes make forecasting 2022 leadership in the markets very challenging, which we think favors broad diversification focused on quality.
U.S. government policy appears to be setting up to have a muted effect on the markets in the new year. 2022 is a midterm election year, which historically has meant no big legislative efforts (a positive for markets). Build Back Better legislation is losing momentum while simultaneously shrinking in size, and previous fiscal stimulus efforts have largely run their course. It is fair to say the economic recovery has been fully handed-off to the private sector, also a positive.
Finally, tensions on the border between Russia and the Ukraine are troubling, but conflict should not have the power to derail global economic growth. Market cycles are not generally impacted by regional conflicts unless global commerce is greatly affected, which a Russia-Ukraine conflict does not make likely. When Russia annexed Crimea in 2014, U.S. stocks were largely unaffected.5