Week ended January 14th 2022
“It is impossible to produce superior performance unless you do something different from the majority.” John Templeton
The second week of the year was only marginally better than the first week for US equity investors, and the themes remained the same. At Jerome Powell’s confirmation hearing before the Senate Banking Committee on Tuesday, he was grilled on how the Fed had gotten its inflation call wrong, which he attributed to a combination of lingering supply chain issues and workers being slow to return to jobs (employment “friction” perhaps?). Mr Powell released a statement prior to the confirmation hearings which you can read here. The fears about inflation were confirmed on Thursday when the BLS released December inflation figures (BLS release here). CPI was 7% in December Y-o-Y, the highest since 1982. Core inflation (ex-energy, ex-food) was 5.5% Y-o-Y, the highest since 1991. Still, inflation slowed slightly in December compared to November, perhaps suggesting that the trajectory is heading in the right direction. US Treasury yields moved higher on the week, especially at the short end of the curve. The yield on the 2-year UST was 12bps higher W-o-W, as bond investors mirrored the Fed’s more hawkish stance, suggesting that the first Fed Funds increase could come as soon as March. There is little doubt now that the most recent print on CPI will increase the Fed’s resolve to address inflationary pressures by more quickly winding down its bond-buying (i.e. QE) programme and embarking on what will certainly be a series of increases in the Fed Funds rate starting early this year. As was the case the first week of January, technology shares most took it on the chin as yields rose.
Earnings season also kicked off this past week as three of the “big six” US banks reported earnings on Friday: JP Morgan, Wells Fargo and Citibank. All managed to beat consensus top and bottom line expectations (albeit there were higher-than-expected provision releases that helped bottom line performance, especially at JPM). Wells Fargo arguably served up the best results of the three banks vis-à-vis analysts’ expectations. On the investor calls following the release of earnings, the management teams identified several common themes that drove their 4Q performance: i) significant uptick in operating costs; ii) less robust trading revenue; and iii) modest if any increases in net interest margin. As a result, guidance / outlooks for 2022 were peppered with uncertainty, and this put pressure on the shares of both JPM (-6.1% on the day post-earnings) and C (-1.3% on the day). The shares of WFC ended the day higher by 3.7%, as WFC most solidly beat its numbers and stands to benefit the most (of the three) from higher short-term rates and a steeper yield curve. The other three major US banks – Bank of America, Goldman Sachs and Morgan Stanley – report earnings next week.
One of the major themes early in 2022 is the effect on stock prices of higher bond yields. Technology stocks have been hit the hardest as yields have increased, and shares in this sector have weighed heaviest on the poor start to the year of the broader indices like the S&P 500 and especially the NASDAQ. Outperforming sectors YtD have so far been banks and energy companies. Here’s how the leading and lagging sectors of the S&P 500 index look YtD, using SPDR (State Street) ETF prices. I have also included ARKK in the table, since this actively-managed ETF is the best proxy for (generally) non-profitable technology companies.
It is worth keeping an eye on the FAMAG stocks given the ongoing volatility in technology shares and pressure on bond yields. These companies begin reporting their results the week of January 24th.
As mentioned, global equity markets generally responded poorly to higher yields and greater economic uncertainty, with the exceptions being the (energy-heavy) FTSE 100 and the MSCI EM index, both of which gained ground on the week. Both the FTSE 100 and MSCI EM index are up 2.1% YtD, whilst the worst performing index so far this year has been the Shanghai Composite.
The US stock market felt fragile much of the week, but things didn’t end up as badly as things felt, at least to me. The broader and more diversified S&P 500 was down a modest 0.3% W-o-W. All of the major US indices are down YtD, with the NASDAQ being the worst performer YtD because of its concentration in technology companies.
Intermediate and longer maturity bonds saw their yields increase modestly W-o-W, but the real action was at the short end of the curve. As already mentioned, the yield on the 2-year UST spiked 12bps W-o-W, with much of the yield increases occurring across the curve on Friday. The yield curve also flattened.
As far as other safe haven assets, gold continued to strengthen ever so slowly, perhaps a reflection of higher inflation and a (slightly) weaker USD. The Yen also increased for one of the few weeks in many, reflecting a combination perhaps of its haven status and a weaker US Dollar.
As far as other assets, oil continues to march higher, a de facto drag on economic activity should prices remain at these levels or continue to increase. Higher oil prices arguably reflect global economic optimism, in turn coming from a milder variant of COVID-19 in the firm of omicron, even though cases are soaring. In all of this uncertainty, BTC managed to rediscover its magic and was up 4% W-o-W, a welcome relief to crypto investors that have seen prices of BTC slump for several months.
In corporate credit, investment grade (USD-denominated) bond yields marched a few basis points higher on the week, whilst yields on USD-denominated high yield bonds actually tightened a few basis points week-over-week. The banks that released their quarterly earnings on Friday reversed more-than-expected of their pandemic-legacy reserves, a sign that corporate credit in the US remains on very firm ground with no trending concerns about rising default rates.