The Week Ahead – Hold Your Horses!

Welcome to “The Week Ahead” where we take a moment to provide our thoughts on what we can expect in markets and the economy during the upcoming week.

Hopefully everyone had a nice weekend. I went horseback riding with the family in the Hollywood Hills on Saturday. I had not been on a horse in nearly forty years. The weather was absolutely gorgeous, giving us incredible views of Los Angeles all the way out to the ocean. The horses were very docile, and only strayed from their well-established trail when they saw an occasional dandelion patch that looked too delicious to pass up. It was a fun day – something I think the kids will remember fondly.

Market volatility continued into last week, with the S&P 500 tracking its steepest decline since the worst of the pandemic. The 10-year Treasury yield rose above 1.80% for the first time in two years, unnerving investors. Interest rates are responding to the Federal Reserve (Fed) becoming much less accommodative, signaling that they are ready to start a campaign of raising interest rates as early as the upcoming March meeting. With inflation above 7%, the Fed has no choice but to tighten financial conditions thus crushing demand. Under this economic backdrop, GDP growth estimates are being cut, which is putting downward pressure on market valuations.

These dynamics are coming at the exact time as Russian aggression on the Ukrainian border is looking like it could draw NATO countries into a potential quagmire. We also are getting fourth quarter earnings reports and, so far, corporate earnings have been somewhat less impressive than hoped. The Omicron variant of Covid-19 has clearly slowed the global economy, but many of the large tech behemoths will be reporting this week. Our view is that a positive fourth quarter corporate earnings story will be pivotal in providing a respite from this recent bout of volatility. Given the strength of the economy going into the Omicron wave, we expect earnings to exceed expectations.

Bigger picture, the economic expansion remains intact:

• Strong labor market
• Surging home prices
• Positive homebuilders surveys
• Vehicle production is expanding
• Oil rig count rebounding
• Positive Leading Economic Indicators
• Excess savings of $2.5 trillion
• Increasing credit expansion
• Federal revenues were up +26% and state revenues +24% on an annualized basis
• Ongoing effects from monetary stimulus
• Inventory rebuilding 
• Supply chain problems easing
• Omicron fading
• Unprecedented surge in Consumer Net Worth

While markets are likely to remain choppy as the Fed begins to raise rates, historically it has been a good time to own equities. Indeed, the last four times the Fed has raised interest rates, the S&P 500 has managed to increase by an average of +90%:

This week’s economic calendar is chockfull of data with inflation being the key theme. The Employment Cost Index (ECI), which is the best metric of wage inflation, likely advanced +1.3% in the fourth quarter. This feeds into strong gains for personal income, which we estimate rose +0.5% in December. New house sales probably dropped last month. Finally, economic growth as measure by GDP likely rose around +5.0% clip and inflation as measured by the GDP deflator climbed +7.0%.

Data deck for January 24–January 28: