Bulls came out of the gate in 2022 on a strong note, sending the Dow Jones Industrial Average to a record high on Tuesday. Optimism was driven by a positive reassessment of the true risk Omicron presents to the U.S. economy. Unfortunately, the Street’s enthusiasm faded by mid-week as the Federal Reserve’s FOMC minutes signaled the Fed would be wrapping up its bond tapering soon and begin lifting interest rates as early as March in an effort to pull back on its pandemic stimulus. The news prompted traders to rotate out of pricey growth stocks, whose earnings are sensitive to rising rates, and into value stocks, which are better able to traverse rising rates and inflation so long as the economy remains strong. This week’s economic readings showed the U.S. economy continued to expand at a healthy clip in December, posting gains in jobs, manufacturing, and services. This helped markets shake off some of their Fed fears, allowing the Dow Jones Industrial Average to remain relatively unchanged for the first week of trading in 2022.
Hiring Falls Short as Workers Call it Quits
With the hot jobs market and Covid surging, workers were not overly eager to head back to the office in December. Nonfarm payrolls missed the mark by a mile with businesses adding 199,000 to their payrolls, well short of Street estimates of 422,000. Still, this was a decent reading despite missing the mark. Interesting enough, leisure and hospitality led the way in hiring despite Omicron ramping up, adding 53K to the payrolls. Professional and business services and manufacturing also posted gains with 43K and 26K new hires respectively. For workers on the payroll, it was a very Merry Christmas indeed with wages up 4.70% year-over-year which has helped take some of the sting out of rising prices. Meanwhile, the unemployment rate fell from 4.20% in November to 3.90% in December, a pandemic low. That’s not far from the pre-pandemic level of 3.50%. The drop was driven in part by a lower workforce participation rate, with fewer people declaring themselves “unemployed”. The reduction in workforce participation could prove a sticky, longer term structural concern. In November, there were nearly 4 million more jobs available than there were unemployed workers. November also saw a record 4.5 million workers quit their jobs. That’s an 8.90% month-to-month quit rate, breaking September’s high-water mark of 4.36 million. With lower labor supply and an expectation of a strong economy in 2022, it’s likely to be a workers’ market for the foreseeable future.
Factory Floors Hold the Line as Omicron Surges
Factory floors managed to keep the supply chains moving even as the Omicron surge began to take hold across the globe. December’s ISM Manufacturing Index posted a reading of 58.7. Numbers above 50 indicate expansion and numbers below 50 indicate contraction. The new orders subcomponent hit 60.4 in December, showing orders continuing to pour in. Hiring remained healthy with the employment index rising 0.90 to 54.2. Despite regional disruptions throughout the world, global supply chains seem to be holding up with the import index increasing 1.2 points to 53.8. Given the attention paid to supply chains during the pandemic, the New York Fed just this week introduced a new global supply chain pressure index which combines several supply-chain measures into one integrated index. The new metric, called the Global Supply Chain Pressure Index, documents disruptions to supply chains since 1997. The gauge has historically moved around its average. However, some notable events have served to push the index higher including the 2011 tsunami which hit Japanese production, and a flood in Thailand which hurt the world’s ability to produce cars and electronics. Of course, those events pale in comparison to the Covid-19 pandemic which saw factories around the globe grind to a halt. The good news in all of this is that the index’s latest reading suggests the worst may be behind us for factories.
Service Sector Posts Exceptional Growth
The growing Covid wave proved to be no match for shoppers as they continued to frequent their favorite establishments in December. Healthy foot traffic sent the ISM Services index to 62. While readings above 50 signal expansion, numbers above 60 are considered to be exceptional. Business remained brisk with new orders, production, and new export orders all registering exceptional growth. However, Q1 2022 may prove to be more difficult for customer-facing businesses given how contagious Omicron appears to be, which could further strain staffing and push prices higher – potentially curtailing consumer spending as well.
The themes for 2022 are outlined as follows – growth, rates/inflation, Covid – pretty much in that order. With Covid dampening in severity (certainly not prevalence), and society having adapted to living with the disease, markets now believe the biggest risk to growth has diminished. The expectation is that 2022’s growth will be solid, with a consensus that 4% growth is pretty much a given. If that proves not to be the case, then look out because that is how markets are set up. This then leaves rates, inflation and Covid flare-ups as the factors that could chip away and sway sentiment as we move through the year. While the Fed had signaled at its December meeting it would begin tightening in 2022, investors didn’t pay much heed since the Fed’s language still suggested that it was committed to keeping rates low (by historical standards). Even with low rates, however, the rate of change in rates can have a big impact, which we’re starting to see. Between December 31st and January 3rd (first trading day for 2022), the yield on the 10-year treasury increased 10.30% (going from a 1.505% to 1.66% yield). The yield rose another 6.30% for the remainder of the week following the Fed’s minutes release, closing 17.6% higher on the week (1.77% yield). Rates have started moving and, according to the CME’s FedWatch tool, there is now a roughly 76% chance for a Fed rate hike in March. That’s up sharply from 39% a month ago. Traders reacted swiftly to the move, rotating out of growth stocks, and sending the tech heavy Nasdaq down -4.53% this week. This masks a much more tumultuous move within growth stocks with nearly 40% of the names in the Nasdaq Composite having declined 50% from their highs, and 66% are down at least 20%, according to Sundial Capital Research. A strong economy in 2022 is still expected, however, so the natural place to park that money has been in economically sensitive, value stocks, which kicked off 2022 with a 1.14% increase. With an accelerated tightening cycle now in the cards from the Fed, the focus will increasingly be on whether rising rates and inflation ultimately cut into expected real growth.