February Market Insights – Markets Lose Ground Amid Inflation and Ukraine

Tuesday, March 1, 2022

Index Performance

U.S. and International Equities

Most equity markets worldwide lost ground for the second straight month. COVID-19 variant cases, sticky consumer and producer prices, and the Federal Reserve’s recent hawkish sentiment have been major themes in investor’s minds. On top of all this, the present geopolitical tensions in Eastern Europe have added to the market’s “wall of worry”. The U.S. small cap Russell 2000 index finished February in the green after being the worst performing major market index in January.

Emerging markets were a bright spot in January after lagging last year on the back of concerns over Chinese regulation and real estate indebtedness. This month, emerging markets lost ground as Russian sanctions for its military actions caused these stocks to finish lower.

Most sectors lost ground in February, following January’s lead. The major bright spot continues to be the energy sector, which returned approximately 7% for the month. The sector continues to ride on the back of higher oil and gas prices as well as the heightened tensions between Russia and Ukraine.

Commodities Mostly Higher

Both oil and natural gas finished in opposite directions last month. Oil’s fundamental case improved on the back of higher demand, improving economic conditions, and fears of supply disruptions from a potential Russia-Ukraine conflict. The major metals, gold, silver, and copper, gained ground in February and reversed January’s performance on geopolitical tensions as well as negative real interest rates.

Fixed Income Continues Lower

The benchmark Bloomberg U.S. Aggregate Index finished lower for the second straight month following negative returns for 2021. Market participants continued to sell off bonds in light of the Federal Reserve’s hawkish sentiment in the face of high inflation. High yield bonds (Bloomberg High Yield Index), which were a bright spot in the fixed income space during 2021 were not spared so far this year. Both developed international bonds (Citigroup World Government Bond Index) and emerging market debt (JP Morgan Emerging Markets Global Bond Index) also lost ground for the second straight month.

“While risks abound, our base case is the Russia/Ukraine conflict may be something markets can get beyond,” explained LPL Research Senior Vice President and Director of Research Marc Zabicki. “However, there should be some bifurcated effects to the market as European equities may lag for longer, given the heavier economic ties with Russia.”

U.S. Economic Data Recap

Inflation: Overall, consumer prices increased for the tenth straight month in January. Moreover, January’s reading marks the ninth consecutive month above 5% for the Consumer Price Index. The Consumer Price Index (CPI) rose 7.5% year over year in January and was higher than what economists expected.

The headline Consumer Price Index (CPI) increased at its fastest pace since 1982. Removing volatile food and energy prices, the core Consumer Price Index increased by 6.0% from a year ago, more than what economists’ expected.

The Producer Price Index (PPI) increased as supply constraints lingered, leading to one of its largest annual gains since the series was updated over 10 years ago. For the 12 months through January, PPI increased over 9.5%, which came in higher than economists expected, following December’s over 9.5% year-over-year increase.  Core PPI, excluding food, energy, and trade services, increased almost 7% year-over-year.

U.S. consumer:  The Conference Board’s Consumer Confidence Index fell to a five month low in February as consumers planning to make major purchases became less optimistic about business conditions in the short term amid COVID-19 and inflationary pressures. Nevertheless the index came in well off the pandemic lows. The survey also showed that even with relatively high inflation conditions, more consumers expect to buy big-ticket items over the next six months.

The University of Michigan Consumer Sentiment Survey dropped to a decade low in February from January to a final reading of over 62.The reading showed that many Americans remain concerned about rising prices across several consumer markets.

Retail sales:  Amid high inflation, January retail sales were reported at almost 4% higher for the month, which far exceeded economists’ expectations.  Online shopping was a big driver of last month’s gain, with non-store retailers seeing a month-over-month increase of over 14% in January. Moreover, furniture and home furnishings sales increased over 7% while automobiles and related parts sales increased over 5.5%.

U.S. home sales: January single family new home sales in the U.S. declined slightly more than economists expected. Rising mortgage rates along with higher home values drove away some homebuyers from the market. Sales dropped almost 20% on a year-over-year basis. Given secular changes in the housing market with changing demographics and COVID-19, demand for housing should remain strong even as mortgage rates increase, which together with high prices, further suppressing affordability.

Sales of previously owned homes in January rose over 6.5% from December, according to the National Association of Realtors. Moreover, the supply of homes for sale dropped to a record low, down over 16% from this time last year.

Small business sentiment: The National Federation of Independent Business (NFIB) Small Business Optimism Index fell to an 11-month low in January amid persistent worker shortages and higher prices for materials. The reading at its lowest point since February 2021. The themes of scarce workers and rising labor costs remain the main areas of worry for businesses.  Both subject matters have been issues for small businesses since the early part of last year.

Federal Reserve news:  Little new information was released in the Fed’s meeting minutes from its January Federal Open Market Committee (FOMC) this month. Fed officials noted that inflation pressures were still too high and that if these price pressures lingered, the Committee would remove policy accommodation at a “faster pace” than they currently anticipate. Moreover, the Committee acknowledged inflationary pressures had broadened over the second half of 2021 and risks to their inflation forecasts were to the upside.

U.S. employment: At the end of January, the U.S. unemployment rate has declined to under 4%, substantially lower than last year’s peak and the labor force participation rate is just below its long term average near 62%. Even though some statistics like the labor force participation rate remain far from ideal, the labor market landscape remains tight. This endorses the view taken by the Fed that the labor market is healthy enough to warrant a more hawkish view.

Looking ahead

As we continue through the economic recovery amid battling the lingering effects of the pandemic, this month, society has been dealt with a major geopolitical struggle in Eastern Europe. On top of this, inflation is proving stickier than many anticipated. The Fed’s hawkish view, along with the bond market, has affirmed this.

Market participants are presently weighing the effects of all these factors, leading to higher volatility and, excluding commodities, declining equity prices. Presently, amid society’s challenges, S&P 500 Index company fundamentals appear intact in light of Q4 earning results.  Our base case continues to be that inflation should begin to stabilize once the economy completes its reopenings, supply chains are fully operational, and labor shortages ease. In addition, in our view, the health of the consumer should continue to be an important driver for the economy and corporate profits in 2022.



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