Interpreting the equity markets lately has been somewhat like reading James Joyce’s Finnegans Wake. Every time you look at it, you think it’s telling you something different. This past week was a wonderful example. Stocks started on a positive note, trending positively through Wednesday, then prices declined on Thursday, only to rebound again on Friday. The week closed with a gain.
The catalysts were some unexpected poor earnings results below expectations for a few companies and positive economic reports, with the latter reinforcing many investors’ view that the Federal Reserve will be forced to tighten more aggressively than previously anticipated. Starting on Thursday after the market close, better earnings were announced by Amazon, and the markets resumed their positive path.
The Dow closed with a gain of 1.05%, the S&P 500 closed up 1.55%, and the NASDAQ closed up 2.38%. At least for this past week, it appears earnings trump the Fed.
As we wrote last week, a number of important events will come about this week. One of the most important is the beginning of the Senate hearings for the three Federal Reserve nominees. The hearings may be contentious. The academic backgrounds of each appear very good, but we are concerned that some will find more personal points to argue. Repeating what we wrote last week, it is important to have the candidates reaffirm that the Fed does not make legislation. It restricts itself to monetary policy and bank regulation. The Federal Reserve is one, if not the most, important economic body in the United States. It is also highly regarded by the public, and is the acknowledged leader of central banks around the globe. Politicians should bear this in mind throughout the hearings.
Central banks now appear to be in agreement that monetary tightening is necessary. The Fed has signaled its intention to tighten. Christine Lagarde, the highly respected President of the European Central Bank (ECB), is clearly in that camp as well. We view this as positive. It is undeniable that the global economic community is awash in liquidity while inflation is far too high. Having said that, a lot should and can be done to stimulate the global economy. It is our understanding that the Administration is rewriting the Build Back Better (BBB) legislation. This is very positive. If a true infrastructure bill can be rewritten, it will be a powerful, noninflationary push to the U.S. economy.
January Economic Update
January’s economic indicators were mixed, as the recent surge in Omicron-induced infections proved to disrupt economic progress in the U.S. As we have commented before, economic indicators are backward looking, so the impacts of the Omicron variant are just now showing up in the economic data. We expect Omicron’s impacts to be temporary, and, with case counts once again trending lower domestically, economic progress should resume in the months ahead.
Inflation remains well above historical averages with the Consumer Price Index (CPI) increasing 7.0% year-over-year. Reopening components like used car prices and airfares continue to have an outsized impact on the headline reading, although core components like shelter significantly contributed to last month’s rise.¹ Alternate measures of inflation that had once offered solace like the Atlanta Sticky-Price CPI, the Cleveland Median CPI, and the Dallas Trimmed Mean PCE² have all turned higher as well. Inflation is also apparent in the labor market with the employment cost index indicating that employers spent 4% more on wages and benefits compared to last year.³ As we have mentioned in prior reports, inflationary pressures over the past year have been fueled by supply chain constraints, stimulus-fueled demand, labor shortages, and rising wages. The Omicron variant could prove to exacerbate global supply chain disruptions, but this should improve as the year progresses and case counts decline. Encouragingly, January’s ISM Manufacturing PMI reported slowing new orders and growing inventories—a promising sign that supply is improving.4 Inflation may prove to be stickier than initially anticipated, but, as supply is replenished and consumer demand shifts from goods to services, readings should moderate in the longer-term.
Gross domestic product (GDP) for the 4th quarter grew at a 6.9% quarter-over-quarter annualized rate, beating expectations for a 5.3% rise and tripling the 3rd quarter’s rate of growth. The strong growth number reflects solid consumer spending earlier in the quarter and inventory rebuilding as companies increased efforts to battle supply shortages and stock shelves during the holiday season. However, there are warning signs under the surface of the report. Most of the growth was attributable to companies investing in inventories rather than people and firms buying goods and services. Furthermore, consumer spending moderated towards the end of the quarter as the Omicron variant triggered a new wave of infections. After contracting 2.3% in 2020, the economy grew 5.5% over the course of the year—the strongest year of growth in four decades. Stimulus payments and low borrowing costs played a large role in fueling 2021’s above-trend growth. Absent additional stimulus, expectations are for growth to moderate in 2022.
There were encouraging signs for the labor market in January. While the unemployment rate ticked up to 4.0%, payrolls surprised to the upside with 467,000 job gains. Furthermore, additions in prior months were revised up by a net 709,000 jobs, and the labor force participation rate increased 0.3 percentage points to 62.2% –the highest level since the pandemic hit in February of 2020. This is even more impressive considering the data collection period coincides with COVID case counts peaking in the U.S., a time when millions of workers were forced into quarantines or caregiving duties.
With nearly 11 million job openings in the U.S., labor supply continues to be the most significant labor market issue, so any signs of workers returning to the labor force is a positive. Potential impacts from Omicron may not yet be behind us, however. Jobless claims provide for a good early indicator of hiring trends, and, with claims rising significantly mid-month, there may be further volatility in the employment situation over the short-term.
Economic indicators were mixed in January. While employment is strong and improving, reigning in inflation remains paramount for future economic progress. While heightened inflation has dampened consumer confidence, it has not yet translated to significantly lower spending. Real time GDP estimates from the Atlanta Fed are worrisome, pointing to 0.1% annualized 1st quarter growth.5 While it is still early, we hope to see this indicator turn higher as Omicron subsides and inflation pressures improve.
We have written in the past about our view that companies expanding the use of technology and investing in innovation will be rewarded. Next week we will discuss globalization.
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1Consumer Price Index Summary. (2022, January 12). U.S. Bureau of Labor Statistics. https://www.bls.gov/news.release/cpi.nr0.htm.
2Personal Consumption Expenditures.
3Rubin, Gabriel T. “U.S. Wages, Benefits Rose at Two-Decade High as Inflation Picked Up.” The Wall Street Journal, Dow Jones & Company, 28 Jan. 2022. https://www.wsj.com/articles/us-employers-labor-costs-inflation-11643331612?mod=hp_lead_pos2&mod=hp_lead_pos1.
4The Institute of Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI) Report on Business is based on data compiled from monthly replies to questions asked of purchasing and supply executives in over 400 industrial companies.
5GDPNow. (2022, February 4). Federal Reserve Bank of Atlanta. https://www.atlantafed.org/cqer/research/gdpnow