The Navigator | January 2022

All three indexes finished higher in December with the S&P 500 up 4.5% and the Dow up 5.5% outperforming the tech-heavy Nasdaq up 0.8%. For 2021, the S&P 500 rose 26.9%, notching a three-year winning streak, while the Dow and Nasdaq gained 18.7% and 21.4%, respectively. Energy and real estate were the best-performing sectors in the S&P 500 in 2021, both surging more than 40%, followed by tech and financials, each rising more than 30%.

The market was volatile in the first half of December as investors weighed the impact of the Omicron variant on the global economy. However, earlier concerns were eased on signs that Omicron might not be as disruptive as initially feared. Both Moderna and Pfizer released data showing that their booster shots are effective in preventing severe infection against the new variant. Further evidence also emerged that Omicron typically results in relatively mild symptoms compared with earlier variants. While lockdowns and restrictions are imposed in some European countries, we do not anticipate major shutdowns or lockdowns in the U.S. In our view, Omicron will partially delay the global economic recovery but will not prevent it.

Inflation remained elevated in November, with the headline CPI up 6.8%, the largest gain since the early 1980s. Meanwhile, the PPI was up 0.8% in November, more than the economists’ consensus anticipated. Although rising energy prices and supply-chain issues were two major driving factors behind the recent price surge, the Fed has certainly felt the pressure to address inflation. While we acknowledge that the inflation risks are to the upside in the coming months, we anticipate that prices will begin to moderate in the second half of 2022 as the supply chain issues gradually dissipate. Anticipated higher productivity in this business cycle should also help businesses absorb higher wage costs, dampening the effect of inflationary pressures.

Still, ongoing inflationary challenges and the tightening labor market have pushed the Fed to formalize the hawkish shift in its monetary policy. In its December meeting, the Federal Open Market Committee (FOMC) announced plans to double its pace of tapering from 15bn USD to 30bn USD per month beginning in January. Furthermore, the expected timeline of rate hikes was pulled forward: the median voting member now expects three hikes this year and in 2023, in sharp contrast to the forecast from its September meeting when only one hike in 2022 was anticipated. As such, we expect the Fed to kick off rate hikes this month, but also expect the effect will be gradual and relatively modest, amid the backdrops of slower but above-trend growth, peaking inflation, and virus uncertainty.

2021 has been a year of remarkable economic recovery and extraordinary equity return, and we see 2022 heralding a new regime of moderation—particularly in terms of growth, inflation, and asset returns.  We anticipate volatility down the road but believe that above-trend growth, negative real yields, robust business investment, and accumulating U.S. household savings will be supportive for risky assets.

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↓ Valuation |

The S&P 500 rose 4.5% in December, and equity valuations remained under pressure. P/E increased from 25.03 in November to 26.21 in December; Forward P/E increased from 21.8 to 22.8. With inflation rising, inflation-adjusted valuation measures remained negative.

↔ Sentiment | The PMI index increased from 60.8 to 61.1 in November, with supplier deliveries falling from 75.6 to 72.2, indicating a gradual alleviation of supply-chain difficulties. Despite the persistent burden of high infection rates and rising energy prices, consumer confidence in the U.S. climbed in December, according to reports from the Conference Board Consumer and the University of Michigan. The consumer confidence index of the Conference Board increased from 111.9 in November to 115.8 in December. The University of Michigan’s sentiment index increased 3.2 points to 70.6, up from 67.4 in November.

↑ Technical | Technical indicators remained optimistic but strained. The VIX level settled at 16.3 at the end of December, compared with 27.2 at the end of November. Fears over Omicron caused a rise in volatility at the start of the month. The market was calmed by signs that the Omicron might not be as disruptive as initially feared, as well as the year-end holiday influence.

↑ Macroeconomic | The U.S. labor market continued to tighten, with the four-week moving average of new unemployment claims falling from 206,500 to 199,250. Inflation remained high, with the headline CPI rising 6.8%, the highest level since the early 1980s. Meanwhile, the PPI increased by 0.8 percent in November, above expectations. After a healthy gain of 1.7 percent in October, industrial production in the U.S increased by 0.5% in November. With modest indicators that supply-chain concerns are no longer escalating, the picture is improving.

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As of 12/31/2021

¹ Source: Bloomberg, WSJ, NorthCoast Asset Management.

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