Fourth quarter gross domestic product (GDP) data, labor and input costs, and the latest from the Federal Reserve’s recent Federal Open Market Committee (FOMC) are driving market volatility in the new year.
As the 2021 year-end roller-coaster market continues, Regions Bank’s Chief Economist Richard Moody, Chief Market Strategist Brandon Thurber, and Director of Equity Research Fran Smitherman shared their latest insights on what spurred the January volatility. Below are key takeaways from this jam-packed discussion on Jan. 28, 2022.
GDP Data Surprises
Key data was released on GDP last week with 6.9% growth reported for the fourth quarter of 2021.
“Sounds impressive, but looking at the details, it is less so,” said Moody. “Inventory accumulation growth was 4.9%, so taking that into account GDP growth was a pedestrian 2%.”
Moody noted that after adjusting for inflation, spending on consumer goods contracted. Additionally, business investment in equipment and machinery fell off in the last quarter, while investment in intellectual property (IP) products remained strong, with double-digit growth for full-year 2021.
“This reflects the growth of businesses investing in automation and technology to enhance labor productivity – a way around finding and retaining labor as labor costs have risen significantly. We are seeing the early stages of a longer-term pattern of businesses investing more in automation and technology.”
Speaking of Labor Costs
Recently released data on employment costs show that after a record increase during the third quarter of 2021, growth in employment costs moderated slightly in the fourth quarter. However, year-over-year, employment costs were up 4% and wage costs rose by 4.5%.
“Labor costs grew more rapidly in the second half of 2021,” said Moody. “The fastest growth came from leisure and hospitality services where firms are still having the most difficulty attracting talent. We think more rapid wage growth will continue in 2022 and that we will see a bigger increase in wages for full-year 2022 than in 2021.”
Moody noted that, while wage growth has been faster, it is still lagging behind inflation. Consumer sentiment dropped to a 10-year low with Omicron weighing heavily, but higher prices are taking a toll, as well.
“We worry about that, as consumers are paying more for necessities, that leaves less for discretionary spending, which impacts the broader economy,” said Moody. “What consumers are living and feeling impacts other segments of the economy.”
Earnings Season
For Smitherman and her team in equity research, year-end earnings season ushers in the opportunity to take stock of the year that was and start looking ahead to what the new year may bring.
“This is definitely a critical time,” said Smitherman. “Right now, we are seeing signs that cost pressures from labor and cost inputs have impacted some companies’ earnings – already making 2022 volatile in terms of stock price performance.”
Smitherman notes that equities were strong, up 28% in 2021, following an 18% return in 2020.
“We expect first quarter 2022 earnings to grow at a slower pace based on labor and input costs that may not be able to be passed through to consumers,” said Smitherman. “We are seeing that sectors that are beneficiaries of rising prices – financials, industrials and energy, which was up 55%, and tech, up 34.5% – all had a chance to shine.”
While rising prices are having a negative impact on consumers and confidence, some companies are benefiting, and Smitherman is seeing a shift in market psychology.
“In 2022, we believe healthcare, financials, energy and technology companies are areas we would focus on in our strategies. We acknowledge earnings will slow and margins will not be able to expand as rapidly, but some areas will hold up better than others against rising prices and potentially rising interest rates this year.”
Fed Policy A Bigger Market Driver in 2022
“We are seeing continuation of heightened volatility in global equity markets and global interest rates,” noted Thurber. “The real pocket of weakness this week has been domestic small caps, which have continued to swoon since December.”
The big story the last week of January was the FOMC meeting, which Thurber points out was the primary impetus for repositioning and additional volatility in the markets.
“There was a Monday downdraft in equities, but we saw a rally of 3.5% off that low throughout the remainder of the week,” said Thurber. “It is unsettling volatility.”
The markets reacted more to the press conference following the FOMC meeting with several comments from Federal Chairman Jerome Powell catching the attention of market participants.
According to Moody, while the Committee made no changes to policy at this week’s meeting, they did reiterate that it would be appropriate to begin raising the Fed funds rate fairly soon, as early as March, which he said was no surprise.
Moody noted that the comment from Chairman Powell that moved the markets the most came in response to a question about the possibility that rising interest rates may disrupt the labor market. Chairman Powell’s response, that “there is quite a bit of room to raise interest rates without threatening the labor market,” led to a sharp reversal in the markets
In the wake of Chairman Powell’s press conference, the markets began pricing in a faster pace of Fed funds rate hikes, with a fifth quarter-point hike now priced into the futures markets in 2022, per Moody.
Though there were no specific details on the Fed’s balance sheet, Chairman Powell suggested the balance sheet would begin running down not too long after the FOMC begins raising the Fed funds rate. But, Moody noted that Chairman Powell stressed the FOMC’s view that shrinking the Fed’s balance sheet should be “stable and predictable,” and that the Fed funds rate, not the balance sheet, will be the FOMC’s primary policy tool as they pare down the degree of monetary accommodation being provided.
Additionally, there was no forward guidance in the meeting, but Powell commented in the press conference that “we’ll need to be nimble over the course of this year so we can respond to a full range of market outcomes” – which the markets seemed to interpret as suggesting the Fed funds rate will rise at a faster pace. Moody suggested that the markets have taken these comments a bit too far in extrapolating how high the Fed funds rate may go.
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