Macro Perspective

After a relatively short break from year-end holidays, global markets started 2022 with a sharp rotation to value in equities and a rising interest rate backdrop for fixed income. Much of the move, in our view, is due to an abrupt change in expectations; the Federal Reserve (Fed) is now expected to increase its policy rate three times in 2022 rather than two. There was no rest for investors to start the year, as Wednesday’s inflation report showed a consensus estimate of 7% on a year-over-year basis, topping the prior reading of 6.8%. We think even as the Fed shifts its focus to what we believe is short-term elevated inflation, there is still an unprecedented level of market stimulus. The Fed alone has a $9 trillion balance sheet, and the G-4 central bank balance sheets are a combined 59% of their collective regional GDP. Equity valuations are historically elevated; however, the structure of the bond market with still-low interest rates and a fairly flat yield curve support those earnings multiples. S&P 500® earnings season kicks off this week, which should further reinforce the ongoing expansion in the face of a number of unresolved issues such as supply chain bottlenecks, the labor shortage and the lingering pandemic

Equity Markets

Domestic equities had their worst start to the year since 2016, with the S&P 1500® down 1.8%. Similar to the start of 2021, where value led after the 2020 elections, there was also a divergence between growth and value in anticipation of swift rate hikes by the Fed. Just like last year, we continue to believe this is a short-term sentiment shift rather than an abrupt change in fundamentals. For example, alongside the two-year yield rising to its highest level since early March 2020, the S&P 500 Regional Bank Index outpaced the S&P 500 by 12.7% last week. The first week of 2021 also saw outperformance over the broader index, to the tune of 7.0%; however, that was also its best week of outperformance for the year.

Developed international equities led global performance on a relative basis as the Financials sector delivered positive returns, supported by rising global interest rates.

Underperformance in growth stocks was no different in emerging markets, led lower by internet-based and Information Technology companies. The monthly semiconductor delivery time report compiled by Bloomberg for December increased yet again, and is now at 25.8 weeks, the longest since records began. Not surprisingly, the increase coincided with a spike in COVID-19 cases in countries such as South Korea and China, disrupting the semiconductor supply chain.

Fixed Income Markets

After flattening for 8 of the past 10 weeks, the U.S. Treasury yield curve steepened at its fastest pace since March 2021. Even with that move, the yield curve remains relatively flat at 90 basis points (bps) compared to the 2021 average of 117 bps. Despite the move higher in interest rates, investment grade credit issuance for the first five trading days of the year was the largest in five years.

Chart of the Week

In an abbreviated start to earnings season, just six companies are set to report fourth-quarter results in the coming week. As of December 31, 2021, the consensus estimate for the blended earnings growth (consensus estimate of companies that have yet to report combined with actual results) is 21.4%. As base effects continue to fade, a number of industries and even the Financials and Utilities sectors are expected to generate negative earnings growth rates. More importantly for investors, however, is the path of earnings revisions, which is slowly beginning to increase, as it did throughout 2021.

For an in-depth look:
View Chart of the Week