Battle Ongoing Between Fed & Investors
We saw the markets respond to the end of QE in 2014 with a temporary sell off that resulting in the S&P 500 Index moving lower by 7.6%. Equities quickly bounced back within a month's time. Markets this year have responded with a steeper sell off (-9.7%). The key difference this time around is inflation. When the Fed began QE in 2014, inflation was very manageable at 1.7% (year-over-year). Right now, inflation stands at 7.1% (YoY). The rest of 2022 hinges on abating the shipping backlog and easing inflation.
The latest numbers from Goldman Sachs suggest the key supply-constrained goods that are the top contributors to inflation could ease as 2022 progresses. New Cars, Used Cars, & Furniture are the largest contributors to inflation among supply-constrained goods.
Indeed, if GS is correct, inflation would ease some later this year. However, the backlog of ships anchored or loitering off the ports has not decreased. Supplier and production material delivery times has eased over the last couple of months as suppliers have leaned on other modes of transportation. This week, the labor department's numbers on Wages will be critical to see if consumers' wages can keep pace with inflation. That has not been the case so far.
The economic data was mixed again last week. Gross Domestic Product (GDP) for the 4th quarter came in much higher than expected (6.9% vs 5.5%). New Home Sales were much higher (month-over-month) and Weekly Jobless Claims were even with expectations, albeit, lower than the previous week. The Chicago Fed's National Activity Index was much lower last month and Personal Income declined. Personal Spending dropped month-over-month, which is not good news regarding consumer discretionary spending.
The volatility in the markets should not be completely unexpected. With regard to 1% daily moves in the S&P 500 Index last year, it was a below average year. Typically, a below average year in volatility is followed by an above average year. There are pullbacks or corrections annually in equity markets.
At least 76% of the time we experience a pullback of 8%, on average. This year, the pullback has been steeper, but that doesn't determine the final outcome of returns for 2022. Since 1980, we've seen double-digit corrections during the calendar year 12 times only to finish the year with positive returns on the S&P 500. Given that we are in a mid-term election cycle and we are battling inflation, expect more volatility this year until some kind of certainty develops to comfort markets.