By: Phil Kernen
What can we make of the market correction? The broad equity markets are off, struggling since mid-December on inflation concerns, advancing and retreating Omicron concerns, and war in Eastern Europe. The economic headwinds appear formidable, but plenty of tailwinds are pushing back.
Inflation – despite price increases growing slowly from early spring, it became apparent by year-end that rising inflation would necessitate Federal Reserve action soon. They wound down their bond-buying program faster and began discussing rate increases. For the twelve months ending February 2022, the Consumer Price Index increased 7.9%, 4x the Federal Reserve’s target for inflation.
The Federal Reserve meets next week, after which we will learn what actions they will take to begin addressing inflationary pressures. They will likely raise the overnight rate by 0.25% and signal six additional 0.25% rate hikes throughout 2022. We will also be looking for signs the Fed will reduce its $9 trillion bond portfolio. Markets despise uncertainty and will carefully watch the Fed’s plans for taming inflation.
War – while case counts from Omicron were declining, Russia began massing troops on the Ukrainian border, followed by the most telegraphed military invasion in a long time. Both countries are heavy commodity exporters, and the effect of war on their prices, and resulting inflation elsewhere, is unclear. The Russian invasion of Ukraine is an evolving story, with the market focus squarely on the surrounding uncertainty.
While it is hard to watch the footage of this war from a humanitarian standpoint, we have much to be optimistic about the U.S. economy and markets.
Excess savings – one result of fiscal policy over the last two years is an excess savings balance estimated at $3 trillion, calculated by comparing the pre-COVID growth trend of the money supply with current levels. Funds held by individuals should help dull the immediate effects of inflation. Funds held by corporations can blunt the impact of higher borrowing rates to fund additional labor costs and investment in additional capacity through acquisition activity. The longer-term for both groups is less certain.
Jobs – according to the latest Job Openings and Labor Turnover Summary (JOLTS) report from the Bureau of Labor Statistics (BLS), 10.9 million open jobs await fulfillment at year-end 2021. According to the latest payroll report from the BLS, 6.3 million workers are unemployed, one of the most imbalanced jobs markets in decades. At the same time, productivity increased 6.6%, evidence employers are investing in technologies to increase efficiency and are thus posting openings for badly needed labor.
Durable goods orders – durable goods shipments and orders continue to increase. As of January, new orders have grown in eight of the last nine months while inflation accelerated, the delta variant advanced and retreated, and the omicron variant advanced. Now that Omicron is retreating, new orders have a more open runway.
U.S. consumer demand is robust, and corporate revenues, earnings, and profit margins are resilient. Thus, we remain optimistic that the strong underlying economic fundamentals will lead us out of the correction when the fog of war lifts.