Week Ended February 11th 2022
“I’d like to see 100 basis points in the bag by July 1…..I was already more hawkish but I have pulled up dramatically what I think the committee should do.” – James Bullard, Federal Reserve Bank of St Louis President
The straw that broke the camel’s back this past week was January inflation numbers for the US, released Thursday morning before the bell. BLS data (press release here) showed January CPI was a sizzling 7.5%, the highest since February 1982, versus expectations closer to 7.2%. This wrecked what was a decent performance in the stock market the first three days of the week, although the real pain occurred in the bond market on Thursday (post-CPI release), most severe at the short end of the US Treasury curve. The yield on the 2-year UST closed 25bps higher (1.61%) on Thursday, the sharpest intraday move since June 2009. The yield curve also flattened on Thursday to levels not seen since April 2020 when the US economy was shut down and the Fed was showering the economy with pandemic liquidity. In most instances when the yield curve has been this flat in the past, it has been caused by monetary policy tightening which eventually led to a recession. The Fed has clearly dug itself into a deep hole, and it will be increasingly difficult for it to navigate a soft landing as it tightens monetary policy to address rising inflation.
It wasn’t just the CPI inflation figure alone that spooked equity markets, but rather comments on future monetary policy from two regional Fed presidents: Raphael Bostic (Atlantic Fed president) on Wednesday followed by James Bullard (St Louis Fed president) on Thursday just after CPI was released. Both men said in separate interviews that they could see a more aggressive series of tightening measures from the Fed, and you can see Mr Bullard’s take on things in the quote at the beginning of this article. The simple truth is that January CPI was one more validation point that the Fed has reacted too slowly to rising inflation and now must deal more aggressively with the aftermath.
On Friday (NYC) afternoon – after markets in Europe and Asia had closed – the UK announced that it is asking its citizens to leave Ukraine, just like the US had a few days before. This was a stark reminder that the situation on the Ukrainian border is highly unsettled. Russia certainly has the means to attack Ukraine should it so choose, with implications well beyond the horror of a regional war as this action would reverberate throughout the global economy. For this very reason, risk assets sold off sharply during Friday’s afternoon session. US stocks in particular took another leg down as investors moved into safe haven assets like US Treasuries and gold. The price of oil also increased sharply on Friday afternoon as global oil and gas supplies could be adversely affected if there were to be a war.
In corporate news, I want to mention two companies that caught my attention this past week: Peloton (PTON) and Walt Disney (DIS). Peloton, which has seen its stock drop 84% from its 52-week high, was the focus at the beginning of the week. Rumours of a suitor for the company – possibly AMZN, NKE or AAPL – pushed PTON’s shares higher on Monday. This news was followed on Tuesday by the company’s disappointing 2Q22 earnings announcement and revised guidance. In response, the company announced that it would replace its CEO and lay off 20% of its workforce. The stock bounce (not to mention a dual-class stock structure) might just keep the company independent, although my two cents is that they should sell themselves if a decent offer comes along. A similar sequence of events could occur involving other beleaguered high flyers that have seen their market values plummet over the last several months, although most have the liquidity to go at it alone at least for a while. The second company under the spotlight was DJIA-component Disney, mostly because of Netflix’s disappointing earnings and subscriber growth stats a few weeks back. Investors are very focused on Disney+, the company’s streaming business. This focus is a bit too much for my taste because Disney is so much more than just Disney+. Disney+ did not disappoint though as subscriber growth far exceeded analysts’ expectations, and the theme parks and other consumer businesses of Disney also delivered outstanding results. I wouldn’t say that DIS is cheap, but the embedded operating leverage in its non-streaming businesses is apparent and – should the pandemic finally be in a winddown mode – DIS will benefit from the ongoing reopening in many parts of its business.
If you want to dig deeper into S&P 500 earnings in the aggregate, check out the Refinitiv weekly write-up here. So far, 358 of the S&P 500 companies have reported earnings, and another 59 are on deck this coming week. Of the 358 companies that have reported earnings, 78% have beat analysts’ expectations this earnings season, above the historical average. The forward P/E for the S&P 500 is now 20, which is getting more reasonable as earnings increase and valuations decrease.
I will mention two final things before getting into the weekly data. First, UK GDP for 2021 (first estimate) came in at 7.5%, the highest since WWII. Before high fiving though, keep in mind that the UK economy still remains smaller (by 0.4%) than it was in 4Q19 prior to the pandemic. You can find the ONS release here. Secondly, the Bank of Japan announced that it would continue with its yield curve control policy that has been in place since 2016, in which it intervenes in the market to keep the yield on the 10-year JGB between 0% and 0.25%. The Japanese central bank reaffirmed its yield curve management policy because – similar to bond yields in other countries – the 10-year JGB yield has drifted higher since the end of 2021, approaching 0.25%. You can find the BoJ’s February 10th announcement regarding its purchase of 10-year JGBs here.
Weekly data including tables
The European, Asian and emerging markets equity indices were all positive for the week, avoiding the malaise that affected US stocks Friday afternoon. As mentioned already, geopolitical tensions around Ukraine came to the forefront Friday afternoon with losses in the S&P 500 (and other US indices) accelerating into the close, meaning that the week ended with two rather dismal sessions. Central banks will be tightening monetary policy as we move forward, at least in the US, UK and Eurozone, with the US facing the most challenging circumstances given the level of inflation. The (energy / financial services-heavy) FTSE 100 remains the best performing equity market YtD, and the S&P 500 is now the worst. While central banks in the US and Europe prepare to tighten monetary policy, China is going the other direction by maintaining its accommodative stance. Putting aside the “x-factor” that could crop up at any time in China, Chinese equities might represent good value at the moment since the market there is also cheap (albeit for a reason).
In US equities, the small-cap (value-play) Russell 2000 is the only index that managed a gain for the week. The DJIA is the only US index that is positive YtD, as tech companies continue to be a drag on both the NASDAQ and the S&P 500. Movements in US stocks are increasingly name specific, but it is clear by now that macro downdrafts drag everything down. I suspect this will continue to be the case as the Fed starts to raise interest rates and wind down its quantitative easing programme. In other words, it will likely be increasingly hard for stock investors to find a place to hide from macro headwinds.
I spoke about US Treasuries at the beginning of this commentary, so I am not going to cover the volatile price action of this past week again. It is clear by now that the yield on the 2-year US Treasury is showing the Fed the way, something I have written about in the past (“Is the bond market doing the Fed’s dirty work?”). Many investors are now expecting five to seven increases in the Fed Funds rate this year, and it is looking increasingly likely that we might see a 50bps increase in mid-March at the next Fed meeting. There is a question though as to what the flattening yield curve is telling us. My bias, as I mentioned earlier in this summary, is that it is indicating a slowing economy because of both the base effect and a shift to tighter monetary policy. The fact that intermediate and longer UST yields are not increasing as dramatically, especially given the January inflation print at 7.5%, reflects the expectation that inflation will be brought under control rather soon. I believe that both assertions are true, and that the flattening yield curve could be signalling a potential recession in the coming 12 to 24 months. Time will tell. The US is not alone in seeing government bond yields increase this year, as 10-year government bond yields in the UK, the Eurozone and Japan have increased 0.54% (to 1.51%), 0.45% (to 0.27%) and 0.17% (to 0.24%), respectively, since the end of 2021 (vs 0.37% (to 1.92%) for the 10y UST).
In corporate credit, it was the higher quality end of the credit spectrum (BBB and BB) that suffered the most from higher underlying UST yields this week, although as is customary, spreads actually narrowed across investment grade and high yield. Yields were higher by 13bps (BBB) in investment grade corporate debt and 4bps in USD high yield corporate debt. If there was ever a time to look at floating-rate (leveraged) loans, which are indexed to short-term bank rates, now is probably the time.
Gold was better bid on the week and surprisingly, given its recent history, is positive YtD. Nothing like a cocktail of ever-increasing inflation and geopolitical concerns to stoke gold out of its deep slumber. The US Dollar also was stronger on the week, up modestly but continuing its trend of strength and – similar to USTs and gold – benefitting also from its safe haven status.
In other assets, WTI crude rallied hard on Friday because of Ukraine situation, continuing its run up to higher levels. At some point, tighter central bank policies will translate into slower economic growth and less demand for oil, but I don’t see this in the near future. Also, some OPEC+ members are struggling to meet their production quotas, and this pressure on supply is also keeping prices elevated. You can bet against oil at your own peril. Without doubt there is a secular trend that will most certainly lead to diminishing demand for oil as the world moves to green energy, but this will be gradual and probably slower than many expect (or hope for). In crypto-land, Bitcoin is continuing to defy sceptics by hanging in there whilst most other risk assets falter, eking out a small gain this week as I write this. Cryptos aren’t my cup of tea, but it is hard not to be impressed at this asset class’ resiliency.