Large-cap stocks reversed the trend of the last three weeks finishing higher by week’s end, but not before falling more than 10% from the highs before recovering. Mid-cap and small caps continued to struggle, losing on the week, with the Russell 2000 index falling almost 20% from the high in November. The Dow Jones was the week leader, closing the week 1.34% higher. From a global perspective, the Dow is considered one of the safer equity indices comprised of “trophy” stocks attracting fund flows from foreign investors as sentiment becomes nervous with the prospect of rising geopolitical conflict. Accordingly, it is not surprising that the European indices were all down, with the pan-European STOXX Europe 600 Index ending the week down 1.87%. The S&P 500 managed a 0.8% increase followed by the TSX up 0.6%, supported by oil, which gained 2.5%, ending the week over $87. The S&P MidCap 400 and the Russell 2000 fell on the week, losing 0.62% and 0.98%, respectively.
Not to be lost on inflation worries and central bank policy responses to inflation, earnings season for Q4 of 2021 is well underway. Thirty-three percent of the S&P 500 companies reported earnings, with 77% beating estimates, barely above the 76% five-year average. The companies beating the estimates exceeded the forecast by 4%, a lower number than earlier in the year and lower than the five-year average of 8.6%. In Q4, the technology and financial sectors were the most significant contributors with negative surprises in the industrials sector – the top detractor. Overall, the earnings are 24% higher than last year due to the impact of Covid on 2021 earnings. From a revenue perspective, 75% of the companies reported revenues 2.5% above expectations and the five-year average of 1.5%.1
The initial indication of economic weakness, due to omicron, surfaced on Monday with the IHS Markit survey for services and manufacturing activity. The Composite PMI Output Index, tracking manufacturing and service sectors, fell to 50.8 in January from 57.0 in December. A reading above 50 suggests economic growth. The flash orders index reading was 55.0, falling slightly from the December reading of 56.6. Compared to the output, the relatively high orders indicate omicron impacted production more than demand. Once restrictions are removed, the manufacturing and services sectors should be expected to recover.2
Further indications of slowing growth for 2022 came last Tuesday in an update from the International Monetary Fund, suggesting global growth will slow to 4.4% in 2022 and 3.8% in 2023. The US and China’s growth, the two largest economies, was attributed to the adjusted lower global forecast with growth in the US cut by 1.2% to 4% and China by 0.8% to 4.8%.3 Consumer confidence in January slipped 1.4 points to 113.8 from December’s 115.2 reading.4 On Wednesday, Chairman of the Federal Reserve Jerome Powell, in his statement, said the central bank would end the asset purchases by the end of March. Further, he said, “the Federal Open Market Committee kept its policy interest rate near zero and stated its expectation that an increase in this rate would soon be appropriate.” At this juncture, the market has factored in three to four rate increases for 2022, with the first-rate rise in March. 5
The final GDP for Q4 released on Thursday surprised to the upside, with an annualized growth rate of 6.9% compared to a Wall Street Journal poll of economist’s forecast of an annualized rate of 5.5%. It was thought inventory re-stocking and consumer spending in the quarter was responsible for the surge.6 Consumer spending for December was down 0.6%, the first decline in 10 months. Adjusted for inflation, the decline was 1%. With inflation running at 7%, wages jumped 7.3%, including government stimulus. 7
There is no question recent economic data reflects the slowing of the economy caused by the omicron variant. Even without the omicron variant, we expect the economy to cool in 2022 after the 2021 accelerated pace, but still grow faster than before the Covid-19 pandemic. If history is any indication, when the central banks start to raise rates, equity markets often move higher, at least during the initial stages. Since present rates are at historic lows, a 1% rate increase by central banks is not likely to impact equities. With spreads between corporate rates and government rates still tight, it signals the market does not expect corporations to default.
On the other hand, inflation is robbing the consumer of purchasing power, which will have a direct impact on economic activity and growth. The present equity market correction could last until the Fed increases rates to fight inflation. Once the policy response starts, we potentially could see a rally toward the end of the year.
Sources:
1 https://insight.factset.com/sp-500-earnings-season-update-january-28-2022
3 https://www.imf.org/en/Publications/WEO/Issues/2022/01/25/world-economic-outlook-update-january-2022
5 https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20220126.pdf
6 https://www.marketwatch.com/story/coming-up-u-s-fourth-quarter-gdp-11643289488?mod=home-page
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Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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