10 January 2022 - The year has started with a bang



What a start to the new year in equity markets, with Technology down 5% and the, once loathed, Energy sector up by 6%, continuing its strong 2021 performance. The reason is very simple: the big spike in bond yields and the realization that the FED could be more aggressive with its monetary policy compared to the initial forecasts. In terms of regions, the S&P500 underperformed all major equity markets, as Technology and other quality growth sectors carry a big weight, while the UK’s FTSE100 posted a weekly gain, thanks to its tilt towards the sectors which benefit from an economic recovery, inflation and eventually higher interest rates (Energy, Materials, Financials).


The “hawkish” minutes of the last FED meeting which were published on Wednesday spooked the markets. It showed a clear worry for inflation among its members, as compared to the more relaxed and “transitory” classification of a few months ago, as well as a strong consensus to proceed fast with the first rise of interest rates. The futures market is now pricing a hike in March with a probability of 80%. If we go back just 6-8 months, the view was that there will be no interest rate hikes in 2022 at all, so things are evolving rather quickly.


The Omicron wave seems to be peaking in various countries, and most medical authorities agree that by end of January, the cases will start to fall significantly. But most importantly, the realization that the tsunami of cases has not resulted in an explosion of hospitalizations or deaths, is causing optimism in markets and adds to the fuel behind the fast rise of yields, which is primarily due to the FED’s possible actions.


Eurozone December inflation rose by 5% on a yearly basis, higher than the 4.7% expected.


The US labor market continues its strong recovery, as per the December’s data. Despite the miss on the headline number of the December non-farm payrolls (199’000 vs expectations for 400’000) the unemployment rate fell to 3.9%, below the 4% threshold which the FED considers as the long-term average rate. At the same time, there was a big positive revision of previous months data for a whopping +144’000, which makes the overall dataset look rather strong.


Another season of quarterly results starts this week. The Q4 season will begin as always in the US, with the large banks and financials being scheduled to report on Friday (JP Morgan, Blackrock, Citigroup, Wells Fargo). The earnings and sales results of the final quarter of 2021 are very important as they could reset the estimations for this year and hence influence target prices. Most importantly, analysts and investors will be looking at the new guidance for the year that companies will have to offer. The bulk of the earnings season is expected to last until the first week of February, a period of increased volatility perhaps.


Government bond yields rose significantly, as already mentioned, due to the triple whammy effect : a) FED b) labor market data, c) small effect of Omicron on economic recovery. The US 10-year yield rose to 1.77%, the highest since last March, while the German 10-year yield is fast approaching again the positive territory, trading at -0.03%. The last time that the German longterm yield was positive was back in early 2019.


The EURUSD has remained stuck in a rather tight range of 1.1280-1.1350, despite the fireworks in bonds and equities.


Similarly, Gold traded close to 1800$, ignoring the inflation fears for now.


Charts of the Week


The green line represents the performance since the start of 2022 of the S&P500 Value index (+1%) which includes sectors such as Financials, Energy and Materials, usually cheap stocks but with relatively volatile growth (so-called cyclicals). The blue line represents the performance in the same period of the S&P500 Growth index (-4,5%), which contains companies with high or secular growth and relatively expensive valuations, with the most typical sector in the category being Technology. The start of the year has created a remarkable difference of 5.5% in favor of Value, as investors are betting again on the re-opening of the economies and the rise in interest rates, which traditionally hurts more the most expensive part of the market. The winners of the previous three years are beginning to feel the heat of a rotation into other sectors.


The US Treasury 10-year yield has spiked more than 20 bps since the start of the year, to reach 1.77%, which is a little higher than the high of March 2021.. Investors are making aggressive bets again that the FED will move faster than previously anticipated to raise interest rates this year. During February-March ‘21 the yield moved almost 80 bps, but from very low levels of about 1%. It is very difficult to envisage a similar pace of ascent from current levels as most analysts forecast the 10-year yield to be at about 2.10-2.30% at the end of 2022. Still however, the move in interest rates has caused significant turmoil to the parts of the equity market which are the most impacted by it: Technology. As most pricing models use the long-term interest rate to discount (divide) future earnings, when the denominator increases sharply, equity target prices will move lower.



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