Global markets were almost wiped out in January, with only a handful of assets protected from plummeting, a sign of investors’ aversion to uncertainty. The Fed set the tone at its first interest rate meeting in 2022 to take a tougher approach to inflation. The next FOMC meeting on March 15 and 16 is the time when the Fed is expected to act. After all, interest rate hikes and shrinking the balance sheet mark the official end of the two-year era of super-monetary easing. Asset prices have fluctuated wildly and the market has reacted. Investors began to speculate about the number and extent of the Fed’s rate hikes and a decision on how to slash its nearly USD 9trillion balance sheet which will be based on economic data.
U.S. jobs report shows gain of 467,000 in January, exceeding consensus expectations of 150,000. Employment growth continued in leisure and hospitality, professional business services, retail trade, transportation and warehousing. The number keeps pressure on the Fed to tighten. This coming Friday, market will be eying on the January CPI number. Economists forecast a 7.3% increase in CPI, which would mark the highest rate of inflation since 1981.
By April, we will begin to see changes in inflation data. This will provide the basis for the Fed’s reliance on data. Yet before that, the market will experience a lot of volatility. The market has priced three rate hikes and the question now is when the Fed will decide to shrink the balance sheet. Market predicts that July could be the starting point and will reclaim at least about USD 500 billion in liquidity each year. The annual shrinking size of USD 1 trillion needs to be driven by external factors. The Fed has a lot of short-term bills on its balance sheet so the Fed can cash a lot of short-term bills very quickly if it wants. Once the Fed can provide investors with a clearer road map for tightening, the market should be able to digest constructively and the yield on 10-year Treasury remains an important indicator. If the curve flattens sharply as the Fed raises interest rates, it could prompt the Fed to take more aggressive tightening measures to steepen the curve.
Economy-sensitive cyclical stocks did well in 2021 as the economy struggled to recover from the epidemic. For the whole of 2021, the S&P 500 index rose nearly 27%, while the sectors of energy (+40.7%), real estate (+42.5%), information technology (+33.4%) and finance (+32.5%) outperformed the market. Utilities (+14%) and essential consumption (+15.6%) rose the least.
Financial sector is the top sector selection amongst the Wall Street consensus in 2022, largely due to reasonable valuations, seemingly strong growth and higher interest rates will boost banks’ profitability. The sector has been unpopular since the global financial crisis. In response to the abnormally high inflation caused by a sharp rebound in consumer demand and to curb economic overheating, the Fed has signalled that it will raise interest rates several times. This poses a threat to stocks that rely on economic growth but it is good for banks, as rising long-term interest rates enable banks to boost profits by borrowing cheaply and lending at high interest rates.
Commodities, especially energy assets, are in a supercycle driven by post-epidemic recovery, geopolitical tensions and supply-demand frictions over the past few years. They also provide inflation protection. Higher inflation is a boon for the energy sector, as higher commodity prices will boost revenues and profits of oil producers, keep their finances healthy and be able to return sizeable dividends to shareholders.
The fundamentals of the energy sector may be sound but valuations have been very cheap for a long time. The sector accounts for only about 3% of the S&P 500, well below its peak of nearly 20%. While demand in many markets has returned to pre-COVID-19 levels, though not all sectors, such as jet fuel, are still about 30% below 2019 levels. By the end of 2023, the normalization of these areas will provide strong support for oil demand.
The cost of capital in the resources industry is getting higher and higher because of ESG’s concerns. Therefore, areas like oil and natural gas, over-investment has turned into underinvestment. Given this outlook, the trend for commodities to outperform is likely to continue. The rise in oil prices will be particularly striking. The prospects for aluminium, nickel, iron ore and sugar are also strong.
The energy shift affects almost every commodity and over time leads to a tighter balance of supply and demand. On the other hand, the energy transformation has created huge new demand, especially for metals. For example, solar photovoltaic requires large amounts of aluminium, copper, silicon and silver. Wind power needs copper, steel and zinc. Hydrogen needs platinum and iridium. Electric cars need more. At the same time, the energy transformation has also brought great uncertainty to the outlook for oil and gas demand. This has affected investment in these goods and is likely to limit supply in the coming years. The current level of oil and gas investment is already in line with the International Energy Agency (IEA)’s “net zero by 2050” scenario, in which oil and gas demand is expected to fall by 30% and 10%, respectively, by 2030. However, there has been no decline in real oil and gas demand in the short term, leading to continued tension in both markets.
After a rough first month of the year, the S&P 500 and Nasdaq Composite erased early losses of the first week trading in February to finish higher to conclude their best week so far this year, led by continued strength in quarterly earnings reports and a better-than-expected January jobs report. Amazon shares surged 13.5% for their biggest one-day gain since 2015 and Snap skyrocketed 58%. Due to earnings disappointment, Meta shares crashed 26%. The Q4 result was a company-specific issue.
Investors are giving Facebook big thumbs down on the lower-than-expected earnings, weak guidance and said user growth has stagnated. Within 24 hours of reporting results, Facebook parent Meta Platforms lost more than a quarter of its market capitalization, some USD 200 billion. It was the largest single-day loss of corporate value in U.S. history and the value destruction might not be over. For Facebook, this is different than the privacy scandals and political controversies that have surrounded the company. This time, the problems are with the business itself. The company said that it’s being hit by a combination of factors, including privacy changes to Apple’s iOS and macroeconomic challenges. It blamed that the lower-than-expected growth is partly due to inflation and supply chain issues that are impacting advertisers’ budgets.
On the other hand, Alphabet reported revenue growth of 32%, proving again that it was able to withstand the pressures from the pandemic and inflation. Its revenue is USD 75.33 billion in Q4 2021 which is higher than the expected. (USD 72.17 billion). Its major revenue came from Google’s advertising revenue at USD 61.24 billion for the quarter, up 33% from USD 46.2 billion in the same period a year earlier. Alphabet announced the split with its latest quarterly earnings, which sent shares up more than 9% post results.
Quarterly results from Amazon, however, were offering some optimism for investors focused on market fundamentals. The company also raised the cost of a Prime subscription to USD 139 a year from USD 119 a year. Shares jumped more than 13% post results. The dramatic moves suggest investors are moving quickly to draw distinctions among the growth prospects of some of the biggest U.S. companies as they reassess their valuations in anticipation of higher interest rates. Investors have shown that they have more faith in the tech companies whose services are seen as stabler than in those whose offerings are more elective. Within tech, we are starting to see a delineation between necessities and wants. Amazon relieved investors with a near doubling in profit in the holiday period. The results showed that Amazon was able to control labor and supply costs better than expected. The company also saw growth in its cloud-computing and advertising businesses.
Companies such as Apple, Microsoft, Amazon, Alphabet Inc. and Meta have powered the stock market higher in recent years. They have become so big that their moves can cause swings in the S&P 500 index. As of February 2, Apple, Microsoft, Amazon, Alphabet, Meta, Tesla Inc. and Nvidia Corp. accounted for more than 26% of the weighting of the index, according to S&P Global.
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