Macro Risk Triangulation
Stocks pulled back in January as investors prepared for the interest rate takeoff. As a result, US large-caps rolled backward to end with losses in the mid-single-digits. Small-cap losses were even more significant in size. The primary place that made any money in the prior month was in the baskets of energy stocks. Net buying returned to energy as investors correctly anticipated that dividend rate hikes would result from today's high oil prices.
The broad stock market has essentially reached the middle and peak of its earnings season when corporate leaders tell us how well they did in the fourth quarter of last year. The corporate results have so far been good, with revenues growing and earnings beating analyst estimates. However, stock prices around the announcement dates have mostly stayed flat. Furthermore, some very well-known companies have seen the rug pulled out from underneath their stock prices after reporting to the market. The problem has nothing to do with the comparables. The trouble is in their forward guidance for 2022.
Corporate America has begun to feel the pinch of an economy recovering from the pandemic. Specifically, everything costs more to produce, assuming labor and materials are even available to proceed with production. As a result, producer prices have reached a generational high, and delivery times reported in the manufacturing surveys remain elevated. Lastly, today's complicated supply picture has directly affected consumers and the prices they pay.
Thankfully, consumer demand still appears to remain robust. And, as economies continue to reopen, discretionary spending may start to move towards more leisure and travel, taking the pressure off the physical goods component of the economy. However, the rising food and energy prices complicate matters even more, especially for those with lower incomes. In addition, farmers are in a race to return to capacity after the pandemic caused them to reduce crops and euthanize livestock. Not to mention the recent wave of cold weather has delivered more challenges. As for energy, it appears the geopolitical risks of Russia sitting on Ukraine's borders are intensifying. In addition, Russia is a significant exporter of natural gas to Europe, and a cold war-induced supply disruption during the coldest time of the year is not ideal. As a result, natural gas prices have been highly volatile as of late. Finally, environmental concerns are placing restrictions and regulations on the fossil fuel industry, which is making it difficult to increase supply.
Therefore, the macro-present risk may be changing. The story may have become less focused on the monetary dangers of government deficits and enlarged public debts and made a turn towards intensified competition and resource scarcity. The global central bank policy is beginning to evolve, but the interest rate policy in the US may not be as bad as some are anticipating. Financial markets were certainly spooked by the comments in the press conference following the latest meeting of the Federal Reserve Open Market Committee. The conclusion left interest rates unchanged but made inflation sound quite problematic by the lead central banker. However, those paying close attention to Honorable Jerome Powell's comments, may have noticed the relative advantage for the US relative to other countries. Namely, the US has a global yield advantage which is likely responsible for the recent strength of the US dollar.
The US yield and dollar advantage are essential for several reasons. First, foreign demand from sovereign wealth funds desires the sovereign US yield because of its higher return and safety. Second, US assets provide a means to keep local currencies pegged. Third, a strong US dollar maintains the pace of domestically imported goods and keeps production costs down. Both are meaningful because they allow the Federal Reserve to perform a smooth landing and help to keep US profits booming.
