January 2022 Market Commentary

January 2022 Market Commentary

Financial Insights

January was not the 2022 start investors were hoping for. Broad losses across global equity markets were the order of the day, although the first trading sessions of the month had brought new all-time highs for the Dow Industrials and the S&P 500. Over the next three weeks, however, stocks turned lower. A strong rebound from severely oversold levels late in the month mitigated the declines but red ink was still in place at month’s end. January performance for key global equity benchmarks is illustrated below.

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For a change, International and Emerging Markets issues fared better than US markets, but the results were still disappointing. In the domestic arena, small cap growth (Russell 2000) and the technology heavy NASDAQ Comp were the weakest segments. The prices buyers are prepared to pay for growth have eroded. 

Fourth quarter 2021 earnings so far, are strong, but positive surprises are fewer and of lesser magnitude than in the previous two quarters.1 We can expect this trend to continue as comparisons to previous years become more challenging over the course of 2022. Each year further away from the pervasive shutdowns of 2020 and 2021 will find earnings “normalizing” and improvements in general, less spectacular. This could exacerbate a trend toward lower price/earnings multiples.

But investors are still likely to see more positive reports than negative this season and while future guidance has turned less optimistic than six months ago and, in some instances, negative, a firm underpinning for most valuations in traditional, cyclical companies could persist this year.  Economic growth is continuing, just at a slower pace.

The twin challenges facing CEOs are obtaining enough workers and keeping profit margins in place in the face of rising wage demands and production costs. Job openings remain at roughly 11 million with approximately 6 million actively seeking work.2,3

For prospective and existing employees, compensation is a primary concern. Over the second half of 2021, inflation was 7% and wages increased 4%, yielding a negative 3% hourly real wage expansion. Clearly, one key to expanding the workforce is to conquer inflation to the extent that purchasing power from wages grows or at least holds steady. The issue for employees is that while raises are typically an annual event, inflation is eroding purchasing power in monthly increments.

The Federal Reserve has confirmed it intends to combat inflation, but tactics outlined to this point seem inadequate. Mr. Powell’s roadmap of four ¼% rate hikes this year will not put a significant dent in the problem, especially since this plan will likely keep interest rates negative though year end. 

Furthermore, even at this late juncture, when it is apparent that inflation is becoming endemic, the Fed is continuing to buy bonds in the open market, albeit at a reduced rate, but these purchases distort the market, contributing to the illusion that the bond market is not concerned by inflation. With its balance sheet now nearing $9 trillion of assets,4 to long-time observers it appears Mr. Powell’s blueprint lacks urgency.  Events and markets may force his plans to change.

In Washington, the Build Back Better Legislation failed in the Senate and despite efforts last month by Democrat leaders to resurrect a streamlined version or to separate segments of the legislation into stand-alone bills it appears that sufficient support for the President’s signature legislation does not exist. 

The November mid-term elections will arrive quickly, and expectations are waning for any major Congressional initiatives until voters have spoken. House Democrats, 29 of whom have announced intentions to retire at the end of their terms, are on their heels after a series of defeats in the Senate.

In Europe, President Biden is facing an important challenge as approximately 150,000 Russian troops menace eastern Ukraine. Whether Putin invades or not, it would seem his goal of curtailing Western influence in the country has already succeeded. Economic activity in Ukraine has slowed and foreign capital inflows are constrained. Putin does not have to invade to create economic hardship and/or chaos in the country.5

But the greatest legacy of this standoff may be the developing fracture in NATO. Dependence on Russian energy has emerged as the overriding determinant of Germany’s foreign policy and the largest European economy appears reluctant to “cross” Putin and to honor alliance commitments.

The UK, US, Poland, Hungary, Romania, and the Baltic States have sent armaments and/or supplies to Kiev, but Germany has so far refused to offer any military assistance.6

Ukraine is not a NATO member but is a buffer against Russia and its client states. Regardless, the region appears to be lurching toward war with a vocal bi-partisan cadre in Washington insisting that Ukraine’s borders be defended.7

Investors endured a rough January, rescued by strong earnings surprises from several technology companies, notably Apple (AAPL) and Alphabet (GOOG). But earnings season will pass, and attention will return to the Fed’s efforts to quash inflation, which as commodity and energy prices suggest, is still accelerating. 

We suspect that Mr. Powell’s announced strategy will not be as effective as hoped and that markets will be subjected to more hikes and possibly in larger increments than currently expected.

Successfully subduing inflation will depend on Mr. Powell’s ability to withstand negative election year rhetoric from the Biden Administration that can be expected to follow any more aggressive Fed action(s). We cannot know his response(s) in advance.

The economy remains statistically strong but is expanding at a slower rate than late 2020 and throughout 2021. Businesses are suffering from labor shortages and overhead increases while consumers struggle to keep up with rising cost-of-living expenses. These conditions could manifest in lower profit margins and slower top line growth for businesses, and in consumer spending retrenchment.

Markets will react rapidly and forcefully to any surprises from the Fed, which in our view, will be necessary if the central bank is to show fidelity to its directive to maintain inflation in the 2% range. We believe the most essential step in its efforts is to eliminate negative interest rates, which would likely mean pain for equity and bond markets. 

We believe equity investments remain the most effective means to preserve purchasing power and that a coherent, well-designed plan is the best defense during inevitable periods of negative returns. It is likely 2022 will be abnormally volatile, typical for a mid-term election year, emphasizing the need for mental and emotional discipline. Long-term investment philosophies need not change in response to the vicissitudes of markets.

1 “Is Q4 the Bottom for S&P 500 Net Profit Margins?” www.factset.com, January 31, 2022. 2 “Job Openings and Labor Turnover Survey,” www.bls.gov, February 1, 2022. 3 “THE EMPLOYMENT SITUATION — DECEMBER 2021,” www.bls.gov, January 7, 2022. 4 “Assets: Total Assets,” www.stlouisfed.org, January 26, 2022. 5 “Ukraine’s Economy Braces for Impact as War With Russia Looms,” www.wsj.com, February 1, 2022. 6 “U.S. approves allied weapons shipments to Ukraine as worries mount,” www.politico.com, January 19, 2022. 7 Ibid.

This commentary is provided for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. Content has been obtained from third-party sources and is believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. The views expressed in this commentary are subject to change based on market and other conditions. The commentary may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.