My view on what's going on in the financial markets and the global economy, and a few other things that might interest me from time to time.

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  • tim@emorningcoffee.com

Week Ended January 28th 2022

“The true measure of common stock values, of course, is not found by reference to price movements alone, but by price in relation to earnings, dividends, future prospects and, to a small extent, asset values.” – Benjamin Graham

 

This was an insane week – nearly another belly flop – as each week so far this year has brought an increasing amount of turbulence. Without doubt, Monday was the mother of all turbulent days, with the Dow down intraday over 1,000 points (-3.3% vs prior close) at one point, before rallying in the second half of Monday’s session to close up almost 100 points (+0.3%) for the day. That is a white-knuckle ride even for the most experienced investors! Each day afterwards seemed to bring more volatility and uncertainty, with a key contributor being the release of the FOMC minutes (and Chairman Powell press conference afterwards) mid-week. However, equities were fortunately buffeted by bookend earnings releases of FAMAG stocks MSFT on Monday after the bell and then AAPL on Thursday after the close, and neither company disappointed. I will discuss this all below in a bit more detail, but let’s just say that a reasonably decent session in US equities on Friday salvaged what could have been a significantly worse week. Believe it or not, somehow the S&P 500 ended higher in this week of nose-bleed volatility and excessive turmoil.


There was some good economic news. US 4Q21 GDP was robust, showing that the US economy remains on course during its post-pandemic recovery. The Bureau of Economic Analysis’ first look (press release here) showed sizzling 6.9% real GDP growth in 4Q21 (annualised), vs 2.3% on the same basis for 3Q2021. For FY2021, real US GDP increased 5.7%, versus a decline of 3.4% in 2020 due to the

pandemic. I read through a few reports on US GDP, and in spite of the record performance, some of the concerns include: the largest component of the robust growth in the 4Q21 was unusually high inventory build (see ING report here) ; personal savings fell in the quarter (perhaps not surprising, but has knock-on effects into markets); and there will likely be an omicron effect on economic growth extending into January affecting 1Q2022 GDP. The robust stimulus-fuelled growth of the US economy will clearly not continue although I believe this is well-anticipated and factored into asset prices.


As far as the Fed, the FOMC minutes were released on Wednesday (here), and I saw no unexpected surprises as far as the hawkish path on which the Fed is embarking. After the minutes were released, Fed Chairman Powell held a press conference followed by Q&A, and this is where things seemed to unravel. In just over a one hour time period during the Powell press conference towards the end of the session, the S&P 500 went from its high of the day (4,453.23) to its low (4,304.8, -3.3%), before rebounding slightly into the close. Clearly, investors were not happy with Mr Powell’s comments. Personally, I heard nothing different than I was expecting – the Fed’s objective is now fully focused on shutting down inflation, and they will use all the policy tools at their disposal to do so, including faster tapering and a series of increases in the Fed Funds rate. Let me paraphrase – the days of free money are about to end. Did the Fed mis-step? Certainly so last year, by waiting too long to decide to shift its policy in order to address stubborn (persistent) inflation before it got out of hand. Is ending this period of excessive accommodation quickly a mistake? Absolutely not in my opinion, although it’s not what investors wanted to hear, especially those that have gotten accustomed to prices of risk assets like equities going in one direction – “to the moon.” I felt the sell-off was an over-reaction, and indeed, investors seemed to eventually come to the same conclusion as shares stabilised the following day. Nonetheless, the reality of what some consider to be a lower strike price on the so-called “Fed put” is un-nerving investors that want to believe that the Fed still firmly has their backs (as far as stock prices).


Fortunately, there was a stabilising force during the week – earnings. Earnings were not necessarily good across the board, but to me, the two companies whose earnings mattered the most because they are such meaningful components of the indices are Microsoft (MSFT) and Apple (AAPL). MSFT smashed their numbers after the bell on Monday, but the “fear factor” was visible post-release in the after-market as the shares plunged (circa 5% down). The concern seemed to be around the growth of Azure (cloud), but these concerns were quickly put to rest during the management discussion of results. The share price recovered, and MSFT ended the week up 4.1% even as the NASDAQ Composite managed to end flat W-o-W. After the market breathed a sigh of relief with MSFT numbers, all eyes were on AAPL which released earnings after the close on Thursday. Similar to MSFT a few days before, this mega-tech FAMAG component delivered stellar results as the company is clearly firing on all cylinders. AAPL had strong revenue growth across all geographies and products (save iPad). The company repurchased over $20 billion of stock in the quarter and raised its dividend. Investors in AAPL were rewarded accordingly, with the shares rallying at the open on Friday and ending the week with a 4.9% gain. These bookend FAMAG earnings helped stabilise a very fragile US equity market during the week. In Europe, the highlight of the week was probably LVMH (Louis Vuitton, Christian Dior + many other brands), which delivered a blistering increase in revenues and earnings for the full year. Revenues were up 44% over 2020 (pandemic-effected), but perhaps more relevant, revenues were up 20% over 2019. LVMH Chairman Arnault spoke of one interesting new frontier in his management discussion, the metaverse.


You can find a good summary of the week’s earnings for the S&P 500 from Refinitiv here. One market statistic that caught my eye in the Refinitiv summary is the current forward P/E for the S&P 500, which is a not unreasonable 19.4x and directionally is heading the right way.


The last thing to note for the week is the continued increase in the price of oil. Some of the increase in oil prices must be attributed to the current geopolitical uncertainty around Ukraine. There is a moderating force that is being ignored at the moment, which is slowing economic growth globally as central banks and governments continue to unwind pandemic-related stimulus. Of course, oil also has the “x-factor” of OPEC+ on the supply side, so it’s hard to tell where prices might go next. In the intermediate term, I continue to like the sector because I do not believe the world’s dependency on oil will diminish nearly as quickly as people are hoping. As a result, many energy company stocks are dirt cheap, and they tend to pay good dividends which provides a floor on prices.


Let’s get into the week. In global equities, it was an end-of-week rally yesterday that pushed the S&P 500 index up 0.8% W-o-W, the only global index I track that was positive for this difficult week. Even with the week’s gain, the S&P 500 remains down 7.4%, YtD. In fact, of the markets I track, the only index that is positive YtD is the energy/financial services heavy FTSE 100 (+1.1% YtD). This demonstrates the benefit of diversification and the value in markets other than the more expensive US stock market. The worst performing markets YtD have been in emerging Asia, with the Shanghai index down 4.6% YtD. Emerging markets more broadly have also suffered from the high volatility and risk-off sentiment affecting developed markets because of the hawkish Fed tilt, higher oil prices, sell-off in high P/E tech shares, and geopolitical concerns regarding Ukraine.

In US equities, the flight to more defensive and stable companies is evident as tech companies are continuing to be re-valued. Fortunately Friday offered a reprieve, although whether or not this rally has legs remains to be seen. The best performing market of the year (relatively speaking) has been the DJIA (-4.4% YtD), whilst the tech-heavy NASDAQ Composite and the small company index Russell 2000 have been the worst, down 12.3% and 12.0% YtD, respectively.

If you want to learn more about the recent performance of the tech sector, you can read the article I published mid-week: “Buy the Dip or Sell the Rip”.


In US Treasuries, the yield curve is continuing to flatten, a traditional indicator showing that investors believe US economic growth will slow in the coming quarters. Even so, yields were higher across the maturity curve, most pronounced at the short end (2y UST yield at 1.15%, +14bps W-o-W) as investors more or less “drag” the Fed into a largely-anticipated series of increases in the Fed Funds rate in the coming months. The Fed’s vagueness as to future policy moves, as discussed earlier, might have also spooked the UST market as investors sold USTs (causing yields to increase). If I were a governor of the Fed, I would be noncommittal too because future changes in the Fed Fund rates and the speed of tapering, eventually followed by quantitative tightening, should remain data dependent.

In other safe haven assets, there is a lot of focus on the US Dollar which continues to strengthen. This is understandable given that the USD is a safe haven currency, and also given that the Fed has mapped out a series of rate rises this year to see off inflation.


What is perhaps more unusual is that the USD and oil prices – which normally move in opposite directions (since oil is a global commodity priced in USD) – are both moving higher at the same time. As far as cryptocurrencies, the volatility this week in Bitcoin specifically was very high (although so was volatility in US equities). Intra-day, $BTC fell to almost $33,000 on Tuesday, its lowest level since mid-July 2021, before recovering as the week wore on to $37,737 (at time I am writing this). I don’t understand what makes the price of Bitcoin change, but even I must admit that Bitcoin has shown impressive resiliency in a time of high uncertainty in risk markets more broadly.


The one thing that I think could rattle markets and the Fed is a deterioration in corporate credit, or in corporates’ ability to access capital in the debt capital markets. This past week saw a fairly significant widening in both credit spreads and yields (through Thursday), which I find slightly concerning. I do not have data for Friday, a day in which sentiment in the risk markets improved. The tables for both yields and credit spreads are below.


Looking ahead Chinese equity markets will be closed all next week for the Chinese New Year celebration. Elsewhere, we will have January economic data start to trickle in since this month ends on Monday. Also, another 107 S&P 500 companies will be reporting earnings this coming week, and I suspect most eyes will again be focused on the reporting members of the FAMAGs: Google (GOOG) on Monday, Meta Platforms (aka Facebook (FB)) on Tuesday, and Amazon (AMZN) on Wednesday. Friday ended on a positive note, so let’s hope that this sentiment carries over into next week as we begin a new month on Tuesday.


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