Capital Markets Perspective brings you what to watch in the markets this week, published in partnership with Great-West Investments.
Week in Review
January 17- 23
Time to leave.
That was the message from the U.S. Department of State to the families of its Ukraine-based diplomats on Sunday, when the Biden Administration ordered some staffers and all employees of Embassy workers in the Ukrainian capital of Kiev to leave the country. The State Department announcement stressed that the reason for the decision was to avoid a messy evacuation in the event of a Russian incursion, which the State Department believes “could come at any time.”
Does that mean an invasion by Russia is imminent? Not necessarily, although President Biden told the press on Thursday that he did indeed expect Russia to cross the border. The evacuation of US personnel from Kiev was therefore a logical next step, whether it was designed to take staffers and their dependents out of harm’s way, to illustrate to Russia and our European allies that the US was taking the Ukraine situation very seriously, or to avoid a repeat of the approval-bruising evacuation of Afghanistan last summer. Either way, it was not a good look for markets.
My view is that big geopolitical stories like Ukraine can be both terrifying and dramatic to read about in a morbid sort of way but are mostly noise from a market perspective. Said a little differently, when things are going well for markets and the economy, something like a border dispute between Ukraine and its former Russian overlords will get a lot of press, but may not have a lasting impact on market returns beyond a day or two of heightened volatility. Past performance doesn’t indicate future results, but case in point: the aforementioned messy departure from Kabul last summer and all the human tragedy that accompanied it took place in a relative vacuum as far as markets were concerned: if you looked only at equity market returns and bond yields during the days and weeks surrounding the fall of Kabul and the frenzied airlift that followed, you’d have a hard time finding even a whiff of evidence that anything unusual had happened on the geopolitical stage. So, when markets and the economy are copacetic, geopolitics are often just noise.
Until they’re not. There are plenty of ways to find fault with any comparison between the fall of Kabul and a potential Russian invasion of Ukraine – they’re not the same thing, and the geopolitical implications are quite different. But that doesn’t fully explain away the fact that big, violent stories like these sometimes capture the imagination of markets and inspire a wave of selling, and sometimes they don’t. But for what it”s worth, markets seem to be paying a lot more attention to Kiev than they did to Kabul. One possible explanation? Things are most definitely not copacetic this time around.
Back in August, COVID seemed to be taking something of a breather and inflation was still officially “transitory.” Rates were tame and the tapering of asset purchases by the Federal Reserve, while whispered about over martinis in a few dark corners of the financial community, was still months away. None of that is true this time, meaning that the Ukraine news may have appeared at exactly the wrong time for markets.
To be clear, the recent volatility in both equities and rates can’t be entirely laid at the Kremlin’s door. In fact, selling pressure in both stock and bond markets have been in evidence since at least the turn of the New Year and, at least in my view, are far more likely to be a result of some of those same factors that were absent when the fall of Kabul hit the newswires, namely COVID (unlike then, omicron is still having its way with us,) inflation (now the highest in a generation,) rates (markets now expect a minimum of 3-4 increases in the Fed Fund rate before 2023,) and the taper (begun in November and then doubled a mere few weeks later.) So, if anything, Ukraine might represent the proverbial straw that broke the camel’s back. But make no mistake, it seems to be making a difference as I write this on Monday morning.
As embassy staffers pack their bags and make their way to the Kiev airport, another element of society that seems to have received the “time to leave” memo is capital market participants. For obvious reasons, equity markets tend get the most attention, but selling has been pretty noticeable elsewhere as well. Take two-year US treasury notes for example: on Tuesday, before Ukraine fears reached their current crescendo, two-year yields crossed the 1% line for the first time since COVID arrived on the scene (remember, bond prices and yields move in opposite directions from one another.) While not quite as dramatic as Russian tanks crossing into enemy territory, that represents a whole other kind of border crossing that was always destined to grab the market’s attention.
Of course, higher rates at the shorter end of the yield curve largely reflect a re-pricing of Fed expectations, with “lift-off” (that date when the Federal funds rate is no longer pegged to zero,) now thought to be perhaps just around the corner. And there is of course a natural feedback loop between rates and stocks, especially higher-growth segments of the market where the promise of future earnings has, until now, supported high and rising prices. With rates also now rising, those promises of future earnings growth look a little less, well, promising, than they did when rates were low (you can thank the magic of discounting math for that little trick.) No surprise, then, that equity market selling had been largely confined to those areas deemed by some to be both too expensive and too growth-y. But that’s not the case today: here at midday on Monday, the number of decliners-to-gainers on the S&P 500 Index is nearly 9:1 in favor of decliners. In other words, the sell-off seems to be maturing and spreading out.
Is that a case of throwing the baby out with the bathwater? Only time will tell. But one variable in that particular calculus that’s sure to gain more and more attention as 2022 unfolds is the state of the US economy. And, as always, I’d be remiss if I didn’t at least mention a few of last week’s indicators that hint at its health.
Make no mistake, the US economy is currently quite healthy. But last week’s most eye-opening view came by way of the regional Fed manufacturing reports: as always, the New York and Philadelphia branches of the Fed led the monthly parade of regional manufacturing reports when they released the so-called Empire State and Philly Fed reports last week. But what caught my eye was that for the first time in a very long while, they seemed to be saying something quite different from one another – the Philly Fed’s version showed robust, continued expansion despite all the things we’ve come to expect as limiters to growth: high materials prices, tight labor markets, and others. But the NY Fed’s Empire State release was a different matter altogether: that report swung wildly and actually dipped into the negative (albeit only mildly so,) indicating “a sudden leveling-off of business conditions” in the region.
Granted, it was only a very slight dip into the negative for the headline Empire State index (-0.7 to be precise,) but…wow. In fact, I had to read the release twice to make sure I hadn’t made a mistake. While the size of the miss relative to economists’ expectations was enough to raise eyebrows all by itself, the huge reversal in Empire State was made even more attention-grabbing by the fact that last month’s reading was still just a stone’s throw from record-high territory.
That said, these kinds of survey-based data can be volatile and even sometimes plainly misleading, so we’ll need all sorts of corroboration before doing our best Chicken Little impression and crying that the end of the cycle is near. But without a doubt, last week’s Empire State report – and even more notably the stark difference between it and the Philly Fed’s version after so many months of implicit agreement – places even more import on the likes of other regional Feds and future ISM and PMI reports to prove that the US economy is still powering forward like a Caterpillar tractor.
I could go on. Last week’s initial unemployment claims data was a mild disappointment, but those numbers bounce around more than the regional Fed reports do (and last week’s figure seems to have been distorted by a large seasonal adjustment to boot,) so they’re probably not worth much more than a mention. Ditto for earnings data (which contained only a few – and sometimes conflicting – nuggets of macro-relevant information,) as well as the half-full plate of housing data we got last week, which did little or nothing to change how anybody feels about the sector.
So what we’re left with is a strong (but perhaps maturing) economic expansion, buffeted by rising rates, a more aggressive Fed, persistent inflation and a stubborn pandemic that continues to defy expectations of its demise. On top of that we now have the very real possibility of dramatic images of tanks and troops crossing borders into streets that aren’t their own, and a little market stress was probably inevitable. Welcome to 2022.
What to Watch This Week
January 24– 30
Notable economic events (January 24-28)
Monday: Flash PMIs, CFNAI; earnings: IBM
Tuesday: Home prices (x2), Consumer confidence, Richmond Fed; earnings: MSFT, JNJ, MMM
Wednesday: FOMC (Fed) announcement; earnings: TSLA, PKG
Thursday: Weekly jobless claims, KC Fed, Pending home sales; 4Q GDP; earnings: AAPL, LUV, STM, IP
Friday: Income and Outlays, UofM Consumer sentiment; earnings: CAT, CL, WY
It’s Fed week. With the Federal Reserve at the center of nearly every conversation that matters to markets right now, Wednesday’s decision and post-meeting press conference will likely get more attention than anything this side of Patrick Mahomes’ 13-seconds-to-victory drive on Sunday. Key questions on just about everyone’s mind will be whether the pace of the taper will be accelerated again, how soon (and how aggressively) the Fed might begin raising rates, and when the Fed might actually start shrinking its balance sheet (rather than just slowing the pace of its expansion as it’s doing now.) On top of that, Powell will almost certainly be asked to update the Fed’s view of inflation, how it might respond to recent market volatility and the risks poised by geopolitical events like a potential Russian incursion into Ukraine.
So it’s probably no understatement to say that Powell’s words (and his body language) will be as closely scrutinized as a Dak Prescott draw play (Dallas fans will understand the reference…) But in the meantime, there will be plenty of other stuff to consider, not the least of which is earnings. Like last week, there’s a little something for everyone, including Microsoft (Tuesday,) Tesla (Wednesday,) and Apple (Thursday.) Those stocks alone should give the growth crowd enough to chew on before the balance of the FAANGs report next week.
But as we’ve all come to learn during the first few weeks of 2022, fast-growing glamour stocks aren’t part-and-parcel of the market, and the post-COVID recovery demands that we pay attention to a few other segments as well. For example, a few companies that could shed some light on whether the chip shortage is relenting at all, including IBM on Monday and STMicroelectronics on Thursday. Sticking with the supply chain theme, a few companies that don’t ordinarily get much attention could also provide unusual insight into the state of the macro environment by providing some read-through into how gummed up the works are (or aren’t,) including Packaging Corp. (Wednesday,) International Paper (Thursday) and Weyerhaeuser (Friday.) For a more direct read-thru, tune in for Caterpillar on Friday, or any of the rail operators reporting this week (Canadian National, Norfolk Southern and Canadian Pacific/Kansas City.)
Of course, that’s only a small sampling of companies scheduled to report earnings this week, and each and every one of them might have something important to say about the economy. For that reason, it wouldn’t be wise to lose focus on earnings even if geopolitics continue to dominate the news.
For a more explicit look into how the economy is performing, two reads of how consumers are feeling are scheduled for this week: the Conference Board’s Consumer Confidence index on Tuesday and the University of Michigan’s Consumer Sentiment Index on Friday. As we’ve discussed here and elsewhere, consumers are starting to get a little wary of how things are going as inflation, COVID, and toxic politics continue to cloud their collective futures. Consumer confidence figures are always among the most forward-looking releases we get each month and are therefore always worth the effort.
Same with purchasing managers’ indices (or so-called “PMIs”), a preliminary read of which we get on Monday. That, and the so-called “regional Feds” (including Richmond on Tuesday and Kansas City on Thursday) will provide an important window into forward-looking trends governing growth, while at the same time hinting at progress (or the lack thereof,) on all the current ills weighing against markets in the post-pandemic era. Given the mixed messages sent by Empire State and the Philly Fed last week, these reports will get even more interesting as analysts look for confirmation about whether economic growth has peaked for the cycle.
And finally, on Friday, we’ll get the latest look at where Americans are earning and spending their cash. This will be the first income-and-outlays report since last month’s disappointing retail sales report and should help explain why Mr. and Mrs. America have suddenly become less spend-y, as well as whether or not it’s temporary or something a little more permanent in nature.
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 Bloomberg, 1/20/22
 Bloomberg, 1/24/22
Personal Capital Advisors Corporation (“PCAC”) is a wholly owned subsidiary of Personal Capital Corporation (“PCC”), an Empower company. PCC and Empower Holdings, LLC are wholly owned subsidiaries of Great-West Lifeco Inc. Source for index data: Bloomberg.com; GWI calculations.