In the first week of the New Year, the investor optimism faded, responding to higher bond yields, December FOMC minutes, omicron news, and economic data points suggesting the economy is far from recovered. Energy and financial shares held up the best, while healthcare and technology trended lower during the week.
The NASDAQ led the way lower, dropping 4.53% with technology stocks impacted by higher rate expectations and a move in bond rates with the 10-year US Treasury topping 1.76% by Friday. Higher rates force analysts to revisit discount rates used on future earnings, lowering technology stocks. The small-cap Russell 2000 fell 2.92%, followed by the S&P 500 down 1.87, the S&P 400 MidCap losing 1.72, and the TSX closing -1.11%, held up in part by the energy sector. The European STOXX Europe 600 was down slightly (0.32%) while the individual country markets were generally higher.
Last Tuesday, the Institute for Supply Management reported its index of American manufacturing grew in December at the slowest pace since January of last year. The index dropped to 58.7% compared to the November reading of 61.1% and a poll of economists conducted by the Wall Street Journal who expected a 60% reading. A reading above 50% indicates expansion, and a reading at 60 is considered exceptional. Once again, manufacturers report strong demand for autos, electronics, furniture, etc., but are limited by materials and labor shortages.1
Last Wednesday, The Bureau of Labor Statistics reported the number of people quitting jobs rose by 370,000 to 4.5 million, the highest figure recorded since the data was first tracked in December 2000. The total number of separations also was up 382,000 from the month earlier for a total of 6.3 million. In a strong economy, a higher quits reading is an indication workers feel secure in finding a replacement job. Higher quits could cause increased wage inflation in the current environment as employers try to attract and keep workers in an already tight labor market.2 At the same time, the number of job openings for November decreased by 529,000 to 10.6 million. A poll of economists by the Wall Street Journal expected the job opening to rise to 11.1 million. The largest decrease in openings came from the accommodation and food services sectors (-261,000) and construction (-110,000). The hires reading was flat at 6.7 million. The non-farm payroll employment was another data point miss, increasing only 199,000 in December against what was expected by economists polled by Reuters to be an increase in payrolls of 400,000. Unexpectedly the unemployment rate fell below 4% to 3.9%.3, 4 Since employment is one of the federal policy makers’ goalposts, improving jobs data is expected to impact future rate increases. As we see improvements, market reactions could create equity volatility.5, 6 The release of the FOMC minutes from December fueled speculation that with the unemployment rate below 4%, policymakers may be inclined to increase rates sooner than anticipated, especially if inflation continues to remain elevated in the coming weeks and months. This put pressure on the bond market, pushing the 10-year Treasury to a new recent high of 1.76% by week’s end.7
The initial claims data showed initial claims increasing by 7,000 to 207,000 from an adjusted previous week’s revised number of 200,000. Continuing claims for all programs for the period ending December 18 decreased by 199,869 to 1,772,352 compared to the same period in 2020 of 20,155,922.8
On Thursday, the Institute for Supply Management services index dropped to 62% in December from a November reading of 69.1%. While still a strong reading over 60%, the latest reading could indicate a slowing economy. With omicron not taking hold until January, the January reading could be interesting and anticipated. 9
As we start the New Year, a correction at some point should not be unexpected, based on current valuations. As witnessed in December, the rotation to more cyclical and value stocks is likely to continue in anticipation of higher rates and response to more persistent sectorial inflationary pressures. With global economic recovery being held hostage to virus policy responses, we are observing fund flows as capital moves to least-restrictive investment environments.
Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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