2022 Outlook & Other Economic News

for the Week Ending 12-31-2022

Treasury yields inched up, with the 10-yr note at 1.5% after hitting an intra-year high of 1.76%. In economic news, MasterCard’s data showed U.S. holiday retail sales increased 8.5% YoY, driven by strong Black Friday and e-commerce performance. Inventories improved in November, primarily through imports, as the U.S. trade deficit grew 17.5% to nearly $98 billion.

In the housing market, pending home sales fell in November after prices surged 18.4% YoY in October. Manufacturing activity in the central Atlantic region increased in December, while Chicago PMI came in above expectations as prices paid and order backlogs eased. Overseas, China’s factory activity expanded in December, with PMI rising to 50.3 from 50.1, and the services PMI exceeded expectations. Finally, Japan’s industrial production jumped by a record in November, boosted by a rebound in auto making.

Muted COVID-19 deaths and less restrictive CDC guidelines following the record-setting omicron variant outbreak de-risked potential virus-related economic disruptions and helped yields rise.

This past year saw a transition from a vaccine-fueled and policy-led recovery to a more fundamentally-driven expansion, at least the last quarter. Market performance was exceptional regardless of the economic and social challenges such as supply chain disruptions, meme mania, and ongoing virus and vaccination issues. So, the big question on everyone’s mind is will the markets 3-year 20+% returns continue in 2022? Let’s take a look at some of the data if anything will indicate headwinds or tailwinds as we begin a New Year

Manufacturing

December manufacturing numbers came out from many regions of the US this past week. The Dallas Fed Manufacturing Activity Index fell to 8.1 after being forecasted for 13.5, ultimately disappointing consensus but still suggesting an improving perception of broader business conditions. On a more positive note, the Chicago PMI posted 63.1, showing strong growth metrics for the Chicago region above consensus expectations of 62.0. The Richmond Fed Manufacturing Index also posted 16, a five-month high driven by increases in new orders and shipments. Read Less

Trade

The November US Advance Goods Trade Balance declined from -$82.9b to -$97.8b, a much greater deficit than the -$88.1b consensus figure anticipated. The large deficit change in November reflects an unexpected increase in imports

Labor

US Initial Jobless Claims for the week ended December 25 fell to 198k, down from 205k the prior week. The figure has recently reached multi-decade lows and illustrates how strong job creation has been this past year. That said, Omicron concerns may affect jobless claims going into the new year, even as economies attempt to remain open. But don’t be fooled just yet by the unemployment rate. We still have many more Americans that left the work force and have not returned. Some are mothers that have not returned because of the need to care for their children, some took early retirement, some making career changes and others are not working because of the vaccination mandate. May will not get the shot and will not look in areas that require the vaccination. This simply means there will be less income to spend on discretionary goods.

Global Equities

Global equities ended the year near record highs even as the current surge in COVID-19 cases surpassed peak levels last seen since the start of the pandemic. That said, markets have largely overlooked case count and have continued to rally on economies remaining open. In the US, the S&P 500 finished 2021 with 70 all-time highs, ending the past week up 1.13%. In Europe, the FTSE 100 rose 0.18% and the STOXX 600 increased 1.10%. The TOPIX also rose 0.41% last week.

Commodities

Oil prices rallied for the fifth consecutive week, with Brent and WTI crude prices closing at $77.78 and $75.21 per barrel, respectively. Rebounding oil prices reflected both receding fears of severe illness from Omicron and falling US crude oil inventories, which declined 3.6 million barrels in the week of December 24. Gold prices wavered last week before rising to $1831 per troy ounce.

Real Estate

Real Estate number are too off the charts home sales have increased even in what was considered the worse months to sell. So, what is behind the home snap up? Institutions are buying up homes as fast as they can pricing many first and 2^nd time home owners out of the market. These institutions accounted for more than 25% of all the homes sold last year and the trend will continue for a while. One of the droving forces behind the institutions investing in the private home market is low interest rates. Its not because they can borrow the money cheaply, it’s because low interest rates have made many fixed income investments unattractive. With yields so low it makes more sense for these funds to buy up single family homes fix them up and rent them out at a premium. Another side effect from the government interfering with the markets and artificially suppressing rates

Equities

Can the markets continue with its 3-year run of +20% returns? Trading platforms such as Robin Hood have driven valuations on companies such as Game Stop, Hertz, AMC theaters. This of course with a little help from Reddit and communication platform for just about anything. The issue ahead is are the prices for many stocks reasonable or are they driven up by strategies such as Index and ETF funds that are fully invested and only issue buy orders. These strategies work wonderfully in up markets with funds flowing into the market, but not so well when outflows exceed the inflows.

Politics

Yes the ugly word, but regardless it does have an impact on the markets. Will China invade Taiwan? Will Russia invade Ukraine? We think the former is very unlikely, with the possible exception of some tiny uninhabited islands off the coast of Taiwan. The latter? If your name isn't Vladimir Putin, you don't know the answer. Either of these could cause a sell-off, but the more important challenge is here at home This coming November we will elect out House of Representatives and several Senate seats. If last year’s gubernatorial elections are any indicator, we could find ourselves with 2 more years of stalemate.

Opinion

Since the Great Recession of 2008 the Fed (Bernanke) instituted near zero percent interest rate and QE (Quantitative Easing). For those not too familiar with QE it is the process of the Federal Reserve purchasing Treasury’s from Banks which injects more cash into the economy, with the idea/hope that the banks will loan the money out to stimulate economic growth.  In order for this to work the Fed needs inflation to grow so that they can charge more for the money borrowed. But after years of trying to move inflation higher (+2% inflation goal), the Fed’s ultra-easy QE policies along with plenty of help from the fiscal side (“helicopter” money, and outsized fiscal deficits). over shot their objective. The financial media tells us every day that inflation is at a 40-year high with many baby Boomers believing a return of the 1970s, with years of ingrained high inflation levels. But that is not the case. We cannot compare the world we live in today to the world of 50 years ago

The current bout of inflation is a result of several issues coming together to create a ”perfect storm” These being supply chain bottlenecks, service sector personnel issues, “helicopter” money, and corporate greed – all of which are transitory, yes that’s right we are going against the grain and stating as we have many times in our newsletters last year that inflation is a symptom of the above mentioned issues. It’s not a chronic/systemic condition. But that doesn’t sell news.

Supply Chains: Supply chains are still somewhat strained. This due to recent Chinese closures of omicron infected areas in China (Xi’an). While certainly of concern, most of the news from the supply side has been relatively upbeat, but we should be cognizant that the pandemic is not over and flare ups may further constrain supply. Nevertheless, there is positive news:

Congestion at the two California major ports has improved, and since they are now working 24/7, it appears that “normal” may return by the end of February.

U.S. ISM Manufacturing Survey shows order backlogs at an index level of 61.9 (November). While still high by historical standards, this has moved down from May’s all-time high of 70.6.

Taiwan, So. Korea, and Vietnam, major chip manufacturers, have all experienced the lowest delays in six months. The same was true for China prior to the latest Covid lockdowns.

So, let’s take a look at the contributors we mentioned that are really contributing to inflation:

Service Sector: The financial media reports the rapid wage hikes in some of the service sectors as if they are economy wide. The latest Atlanta Fed Wage Tracker pinpoints the escalating wage issues to the lower educated and unskilled (mainly younger) in the services sector which is responsible for about 20% of the workforce. The other 80%? Not Much of an increase

Service Sector Personnel Issues: Pre-omicron, service sectors like restaurants and airlines were re-approaching 2019 levels of activity. But Omicron has had an impact or should we say the media? Looking at Open Table’s report of falling restaurant bookings and havoc occurring with airline schedules (cancellations) over the Christmas holiday weekend, many are calling in sick or staying away in fear of getting sick or required to remain at home if felling slightly under the weather. 

With a majority of schools back to having students in the classroom, many working mothers have begun to return to the workforce. We saw in the November jobs data that the Labor Force Participation Rate for young females rose, and we expect December’s numbers to continue to show such gains.

“Helicopter” Money: Much of current inflation has been caused by the policies of our government. Giving out free money of both the Trump and Biden Administrations is the main culprit. A simple example: A worker in a widget factory makes one widget per day. If laid off, the widget isn’t produced, but the worker has no income. Both supply and demand have fallen. By the government giving away free money, the widget didn’t get produced, but the worker still had income, and demand remained or increased. When the government infers it generally has a poor outcome, in this case it produced demand/supply imbalance which created inflation. That has now gone away. The last of the helicopter money went out in December in the form of “child care” tax credit payments (which are really pulled forward from 2021 taxes due next April!). Without “free money,” 2022’s growth rate will be impacted!

Greed: Is it Greed or just good business? There have been reports of corporations taking advantage of the “inflation narrative” and raising prices at a faster rate than the cost of inputs because they know customers, (having been saturated by the media with the “shortage” narrative), would not object, apparently happy to have product available at all. This is a problem that is solved by “competition” in a capitalistic economy.

Thus, it appears that, while inflation may be elevated for a quarter or two, it ultimately will prove to be “transitory” in the sense of “not permanent” or “long-lasting.” (The term “transitory” appears to have gotten a bad name because of the need for “instant gratification” now imbued our culture.)

Things to be aware of

Fixed Income: The yield curve has flattened – short-term interest rates are rising due to an increasingly hawkish Fed while long-term rates are holding steady as the economic outlook softens. An “inverted” yield curve (short-term rates higher than long-term) has always resulted in recession. While we are still not there, a flattening yield curve serves as a first warning.

Equity: We end the year with the equity markets at or near all-time record highs. But, under the hood, our economy may not be all that healthy. Approximately 20% of the companies in the S&P 500 are still considered zombie companies, meaning that they are able to make their interest rate payments but not anything toward the principal. If/when the Fed raises interest rates these companies will be the first to crumble. While many good business operators would realize the benefits of low interest rates, low rates can also add to bad decisions such as buying back stock with borrowed money or taking on too many risky investments. Hence the danger comes when rates go up those companies go down and layoffs begin.   

Economist David Rosenberg points out that one-third of the stocks in the Nasdaq are 50% lower than their 200-day moving averages, and that over the past eight months, five stocks (AAPL, GOOGL, NVDA, TSLA, and MSFT) have accounted for half the S&P 500’s total return. In addition, he points out that mutual fund redemptions and sales of ETFs have markedly increased of late.

History tells us that stocks take a breather, especially after three years of significant double-digit returns. The Fed has taken its first baby tightening steps with hasher moves scheduled for 2022. Equities usually react poorly to Fed tightening (remember 2018), and this time, to compound the issue, the Fed will be tightening into a slowing economy. History also tells us that, under such circumstances, a soft landing is highly unlikely. We expect a lot of market volatility this year pending the Feds policies.

Keep in mind that everything will depend on how people behave/react to the news over the Omicron virus. We are living in an age of fast and inaccurate information. Misinformation could be our biggest hurdle.

A market correction of length and significance depends what the Fed does, so we believe it’s best to be conservative and assume the Fed will raise rates beginning in the next few months.

Keep in mind a flattening yield curve is not a positive sign for economic growth. While short-term rates may rise due to Fed policies, longer-term rates are sensitive to economic growth – so our forecast remains Skeptical. Source: Robert Barone, Ph.D.

The Week Ahead

A new year begins, and the slate is wiped clean. The first trading week is typically closely watched as a potential barometer for the market’s trend in the year ahead. In the U.S., a full calendar of economic events awaits, highlighted by employment data and FOMC minutes. Tuesday’s ISM manufacturing PMI kicks things off and is expected to ease slightly. Shortly after, the JOLTS job openings report emerges. Wednesday brings the ADP private payrolls along with December’s FOMC minutes, where investors will look for more clues as to the first interest rate hike. On Thursday, ISM services PMI and factory orders drop. It all leads into Friday’s important NFP report, where economists expect an increase of 410K jobs after November’s disappointing release. Internationally, OPEC will meet Tuesday and is likely to go forward with their plan to add 400K barrels per day of supply in February, despite global disruptions from surging virus cases. Eurozone data will focus on inflation, PMIs and retail sales. China’s economy has been giving markets some anxiety, and Tuesday’s Caixin manufacturing PMI will be attentively scrutinized. The week closes with Canada’s jobs report and Ivey PMI.

This article is provided by Gene Witt of  FourStar Wealth Advisors, LLC (“FourStar” or the “Firm”) for general informational purposes only. This information is not considered to be an offer to buy or sell any securities or investments. Investing involves the risk of loss and investors should be prepared to bear potential losses. Investments should only be made after thorough review with your investment advisor, considering all factors including personal goals, needs and risk tolerance. FourStar is a SEC registered investment adviser that maintains a principal place of business in the State of Illinois. The Firm may only transact business in those states in which it is notice filed or qualifies for a corresponding exemption from such requirements. For information about FourStar’s registration status and business operations, please consult the Firm’s Form ADV disclosure documents, the most recent versions of which are available on the SEC’s Investment Adviser Public Disclosure website at www.adviserinfo.sec.gov/