Bulls and bears managed to reach a détente despite the conflict in Ukraine escalating this week. After months of building up forces along Ukraine’s border, Russia launched its invasion of the country in the early hours of Thursday morning. The operation took place both by ground and air across several key locations around the country. The breadth of the operation initially spooked markets with the Dow plunging 800+ points at the open. In the melee, the NASDAQ index fell into bear market territory, down -20% from its all-time high. Bond markets provided cover as investors flocked to the safety of the 10-year treasury, which pushed yields below the key 2.00% level. By the close of trading on Thursday, however, bulls managed to find comfort both in the Western nations’ response and in the conflict’s implications for domestic monetary policy, resulting in most U.S. equity indexes gaining on the day. With all eyes on Ukraine, markets generally ignored the week’s economic reports on personal spending and durable goods which showed the U.S. economy is still running strong. News of potential Russian and Ukrainian negotiations sustained the bulls’ momentum on Friday and resulted in most equity markets finishing up for the week.
Rising Prices Fail to Hold Back Consumers
High prices in January failed to deter consumers, who increased the value of their expenditures by 2.10% for the month. This managed to beat estimates of 1.60%. Spending rose even as the core personal consumption expenditures price index, the Federal Reserve’s primary inflation gauge, increased 5.20% from year ago levels (excluding food and energy). That was its highest level in nearly 39 years and well above its 2.00% target level. The strong spending number is not all good news, however. The spending growth rate is reported in current dollars, meaning that it includes the impact of inflation. Controlling for inflation, spending was still higher by 1.5%, but that only went to negate the -1.3% real spending experienced in December. Personal income was flat in January as the end of child tax credits more than offset wage gains and an upward inflation adjustment to social security checks. In real terms, personal income actually declined -0.5%. The personal savings rate also continued to tick lower. That helped support spending and signals consumers remain confident in the economic outlook, but at the same time it reduces their buffer should we experience a slowdown. The personal savings rate dipped to 6.40%, which is below the pre-pandemic level of 7.80%. While the headline reading may have initially seemed rosy, the number itself masks the impact inflation is having on families and with international events disrupting oil, food and commodity markets, the consumer is likely to start really feeling the impact further in the coming months.
Durable Goods Orders Soar
Orders for long-lasting goods jumped 1.60% in January, beating expectations for a 0.80% gain. The increase was driven by a 3.40% increase in orders for transportation equipment. Orders for non-defense capital goods excluding aircraft, a closely watched proxy for business spending plans, rose 0.90% month-to-month. That’s up from the 0.40% rise in December. Durable goods readings have been consistently strong over the past twelve months. More importantly, the capital goods portion of the durable goods report was particularly strong in January. These are orders, shipments, unfilled orders and inventories of equipment companies use to actually produce end goods – typically consumer goods. Within the report, however, there is a section that specifies defense orders, and given the conflict unfolding in the Ukraine, we thought it might be heartening to point out that defense-specific, capital goods orders increased 15.7%, while defense-specific, capital goods shipments increased 4.2% in January. We can only hope that this equipment will soon be busy producing munitions and equipment that will give ’em hell on the front lines in defense of freedom.
Wars evoke a macabre curiosity. Part of it is the fascination in seeing all the military power and technology on display, but on a more humanistic level, wars play to our basic values. Democracy versus dictatorship. Security versus terrorism. Good versus evil. For markets, however, wars are more nuanced, which helps explain why as the world condemned Russia’s unprovoked attack on the sovereign nation of Ukraine, U.S. markets were little changed. Russia militarily punches far above its economic weight class. Depending on the price of oil, Russia’s economy is roughly the size of South Korea’s or Italy’s–and slightly smaller than Texas’. For the U.S., the direct economic ties to Russia and Ukraine are very limited. The more diffused economic impact comes via the conflict’s disruption to commodities markets, the potential for additional supply chain problems, and slower global economic growth. Ukraine is a key supplier in global agriculture. According to the USDA, Ukraine is forecasted to account for 12% of global wheat exports and 16% for corn. Russia, for its part, is a major oil producer and one that is deeply integrated in Europe. The conflict’s disruptions to the food and energy sectors have the potential to compound factors that are already contributing to high global inflation. While that is a concern, markets were ultimately comforted that the harshest of sanctions were not implemented, which will allow oil to continue flowing. At the same time, markets now believe the Fed will be more cautious in raising rates given the uncertainty to economic growth the conflict now introduces. As sad as it is, markets are making the same bet Putin has already made, which is that the sting of sanctions won’t be severe enough to materially change the conditions on the ground.