The Navigator | February 2022

Rising interest rate fears and growth worries pushed the S&P 500 Index to its worst month since March 2020, posting a loss of 5.2%. The Dow Jones Industrial Average lost 3.3%, while the tech-heavy Nasdaq Composite slumped 9%. On a sector basis, technology, consumer discretionary and real estate underperformed, while the energy sector gained 19% to far outperform the market. Financials and consumer staples proved to be defensive assets during the rotation.

In its January meeting, the Federal Reserve held rates at near-zero, reaffirmed that it would wrap up the tapering process in early March, and signaled the potential for the first increase in the target fed funds rate as early as March as well. While Fed Chairman Jerome Powell did not directly address potential rate hikes at several meetings, he hinted at the possibility of a faster pace as he emphasized intensifying inflationary pressures since the central bank’s December meeting. He also acknowledged that monetary policy needs to address different outcomes, including inflation running higher. The Fed’s latest statements were much anticipated as investors try to price in more aggressively hawkish central bank policy. The S&P 500 gave up a 2.2% gain after the Fed’s announcement and closed 0.2% lower, while the two-year US Treasury rose to 1.15%.

One encouraging development this month is the start of a COVID case decline in most states in the US. While the virus is still lingering and effects of Omicron are still somewhat severe, those effects will likely be more constrained as the year progresses. Additional waves may follow, but the combination of vaccinations, natural immunity, and pending home treatments would help to further moderate COVID impact, leading to potential easing of supply chain pressure and possibly moderating inflation.

The sentiment and macro signals were mixed in January. Amid a broader slowdown due to the Omicron variant, U.S. manufacturing conditions softened in December as the ISM manufacturing index fell from 61.1 to 58.7. Factory sentiment in the New York area also crumbled in the first half of January. However, on the positive side, U.S. GDP posted a better-than-expected 6.9% annualized rate in Q4. Meanwhile, initial jobless claims were markedly lower after notching a three-month high in the previous weeks, suggesting some of the Omicron-related disruptions may be easing.

Overall, we view the recent pull-back as a short-term correction and essentially a belated recognition of the Fed’s hawkish shift. Our forecast remains that the fundamentals of the U.S. economy will prove resilient to the Fed’s tightening process and will continue to recover, though at a moderate pace. After the sharp market sell-off, we believe opportunities may begin to arise, particularly in more cyclical areas of the market as the speed of hawkish surprises slows down and Omicron’s impact fades. While we remain optimistic about the reopening outlook, we are being more selective and especially cautious of those assets most sensitive to a faster pace of Fed tightening. Also, we expect volatility down the road as markets overreact in one direction or another as new information comes in.

NorthCoast Navigator

↓ Valuation | S&P posted a monthly loss of 5%; valuation for equity improved with the market pull-back but remained negative. P/E: decreased from 25.55 to 24.11; Forward P/E: fell from 22.7 to 20.4; Inflation-adjusted valuation metrics continued to be negative with inflation rising.

↔ Sentiment | U.S. manufacturing conditions softened in December as the ISM manufacturing index fell from 61.1 to 58.7. However, the drop in supplier deliveries index (from 72.2 to 64.9) indicated faster deliveries. Consumer confidence remained depressed as indicated by the University of Michigan sentiment index, which fell from 70.6 in December to 67.2 in January. Omicron infection was likely a significant contribution, while a falling stock market and high inflation weighed on sentiment. After four consecutive months of increases, home builder confidence reversed the trend and inched down in January to 83 but remains well above the 50-point threshold. The short-term outlook remains positive with strong demand, though rising costs and poor availability of construction materials could be challenging.

↑ Technical | Positive as reversal and fear index outweighed momentum indicators. The S&P 500 was 2% above its 200-day moving average, 1% below the 100-day average, and 3% below the 50-day average. VIX: settled at 24.8 at the end of January compared with 17.2 at the end of December. Volatility spiked this month as investors digested the hawkish Fed pivot, persistently high inflation data, and geopolitical risks. The reversal signals became positive with the market sell-off.

↑ Macroeconomic | December’s payroll data was disappointing, with payrolls increasing by far less than the consensus forecast, up less than 200,000. On the other hand, high frequency initial jobless claims data dropped to 260,000 in the week ended January 22, indicating that the Omicron variant’s impact on the U.S. labor market is beginning to moderate. Inflation remained elevated in December, with the headline and core CPI up by 7% and 5.5%, respectively. Meanwhile, the PPI was up 0.2% in December, less than the consensus anticipated. U.S. GDP growth accelerated to 6.9% in the fourth quarter, according to the preliminary estimate, up from 2.3% growth in the third quarter.

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As of 1/31/2022

¹ Source: Bloomberg, WSJ, NorthCoast Asset Management.

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