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Drawn Down — Week of January 24, 2022

Written by Steve Orr, Chief Investment Officer, and Mark Frears, Investment Advisor

index wtd ytd 1-year 3-year 5-year index level
S&P 500 Index -5.67 -7.66 15.74 20.72 16.21 4,397.94
Dow Jones Industrial Average -4.55 -5.63 11.96 14.44 14.07 34,265.37
Russell 2000 Small Cap -8.07 -11.44 -6.27 12.27 9.37 1,987.92
NASDAQ Composite -7.55 -11.98 2.45 26.33 21.09 13,768.92
MSCI Europe, Australasia & Far East -0.60 -0.70 7.89 12.25 9.53 2,318.85
MSCI Emerging Markets -0.13 1.96 -8.70 10.27 9.84 1,255.74
Barclays U.S. Aggregate Bond Index -0.26 -2.07 -2.83 3.97 3.13 2,306.28
Merrill Lynch Intermediate Municipal -0.34 -1.26 -0.48 3.60 3.41 316.07

As of market close January 21, 2022. Returns in percent.

Drawn Down

Stocks are plumbing lower levels on a variety of excuses. How about reasons? There are three at the top of our list: 1) economy great to good, 2) TLTF2, 3) omi-chronic. The S&P 500 fell 5.7%, Dow(n) Industrials -4.6% and the NASDAQ -7.5%. Every index except the Dow Utilities broke below their 200-day moving average. This is the first drawdown below the 200 day for the S&P 500 since March 2020. Small cap and NASDAQ are now in corrections, their first since March of last year. Fleeing from stay-at-home tech companies, traders have pushed NASDAQ to its worst annual start ever. Digging in the dust-bin of bad memories, the year-to-date numbers above are gunning for 2009’s worst January ever. 

January is usually one of the three best months of the year. Usually there is a drawdown in the middle of the month, followed by a decent rally during earnings at the end of the month. Eleven of the last 20 Januarys have had at least a 3% drop during the month. Most recovered during the last week to finish flat or up. That will likely not be the case this month. The phrase “History doesn’t repeat itself, but it often rhymes” is attributed to Mark Twain. We would be happy with stocks rallying back to flat.

Since the NASDAQ peaked last November, investor sentiment slowly deteriorated. Last week’s selloff pushed sentiment deep into Gloom territory. We would point out that nearly every time investors get this depressed, stocks are higher a year later. 

The Top 3

The Street senses that the economy is weakening. According to the Census Bureau, over eight million U.S. workers have missed work this month for Covid issues. That is roughly 5% of the workforce absent or trying to work from home. Jobless claims have jumped higher the last two weeks. In late 2020 during the first wave, their estimates barely reached six million. Retail sales have been lower month-over-month since October. Schools are temporarily closing. The only silver lining we can find about “chronic  omicron slowdown syndrome” is that daily case counts appear to have peaked during the first week of the month. 

TLTF2

Last November the Fed announced it would accelerate the wind-down of its bond buying program. Since then, stocks have struggled. Yes, indices reached new highs but could not sustain those levels. Roughly half of the S&P 500 is now in correction mode and only 16% of the S&P stocks are above their 20-day moving average. 

Recently, Fed speakers have warned that more rate increases than forecast are possible. The minutes of the last Fed meeting indicated that the Fed is also considering selling some of its Treasury and mortgage bonds. Traders have responded by marking bond prices lower. As a result, bonds, like stocks, are off to one of their worst annual starts in many years. 

Last week we wrote about how the Fed can raise rates too far and sometimes too fast. In 1994 they did both. We did not do a good job of laying the predicate. In each of the tightening cycles in the modern era (post-Nixon gold standard – the Fed waited too long. By the time it got started raising rates, inflation had taken hold, or bubbles were close to bursting. Rate increases were just more gasoline on the fire. Or as James Rickard said in 2013, “they (the Fed) think they are playing with a thermostat…but they are playing with a nuclear reactor.” We think the Fed should have started raising rates a year ago. Vaccines were widely available, and the economy was back in expansion mode. When it comes to raising rates, the Fed is chronically Too Late in the business cycle. Once they decide to act, the Fed usually raises Too Far or Too Fast – or sometimes both.

A good indicator of Too Far is the Treasury yield curve. The difference in yield between the two-year maturity and the 30-year maturity can give a signal as to future rates and growth. When the two-year interest rate is higher than the 30-year, the curve is said to be inverted. Most inversions happen because the Fed is raising rates so Far that traders fear future growth will be impaired, and in turn lower long-term interest rates. Right now, the difference in those two rates is about 1.05%, the same level as the start of the pandemic. Note that the average for the two-30s spread is close to 1.9% or double today’s level. 

Hanging Out

The Fed meets this week. The Fed should outline its plans for ending asset purchases, raise rates and possibly sell bonds. Economists believe the Fed will wait until the March meeting to raise short-term rates a quarter of a point. At this point markets are hanging out waiting for word. The only forecast traders are “sure of” is that the Fed could raise rates four times this year. That would push short-term rates to 1%. 

We think the call for four rate increases may be overdone. The rate of price increases is likely to slow by midyear. Forward rates, inflation swaps, breakevens and the Treasury curve all suggest that inflation will not be near as high in the next few years. A reasonable path for the Fed this year is two quarter-point increases by the middle of the year, stop to check inflation and economic growth, and perhaps another quarter-point increase in the fall. We realize we are at the low end of rate projections in this scenario. 

Still Good 

We led off the week with the National Association of Home Builders (NAHB) Index, showing an 83 reading for January versus last month at 84. This takes a pulse on the single-family housing market by surveying home builders around the U.S. The three components are Single Family Sales: Present at 90 (90 December), Single Family Sales: Next six months at 83 (85 December), and Traffic of Prospective Buyers at 69 (71 last month). This is all based on a scale of 0-100. We are still in solid territory from the builders’ perspective.

Building permits and Housing Starts both came in well above expectations. Permits jumped 9.1% in December, moving to an eleven-month high for an annual pace of 1.87 million units. Starts reached a nine-month high of 1.7 million units, up 1.4% in December. Despite the scarcity of raw materials and the cost of labor, the home building sector is responding to continued demand.

To finish off the week, Existing Home Sales fell 4.6% in December, to an annual rate of 6.18 million units. This is a measurement of closed sales, and 2021 was the strongest year since 2006, up 8.5% from 2020. So, make sure you dig deeper into the numbers, and don’t just stop at the negative December reading. Due to strong demand, there is only approximately 1.8 months’ supply available in the market, down from a balanced market between buyers and sellers of four to six months. Sellers are in control.

Where Are We Headed?

The Conference Board released their Leading Economic Indicators (LEI) for December on Friday. It came in at 120.8 (2016=100), up 0.8%. These indicators cover employment, manufacturing, housing, stock prices, credit, interest rates and consumer sentiment. This indicator is back above levels seen before the pandemic, on a strong upward trajectory. There is also a coincident indicator published and it is also on an upward trajectory, but at a lower level and slower pace.

Early Season

Not all the red on your market screen is indices. Individual stocks that give solid to good earnings reports are being kicked to the curb. The folks that miss (see Ecolab or Peloton) watch out. Goldman Sachs and JP Morgan both had good quarters and found their stocks 6% down on the day. Netflix closed last Friday down 20% on the day. Bespoke Research points out that over the last 20 years the stock has had six other earnings day declines of 20% or more. Sound like Squid Game for your P&L statement to us.

For the broader market just over 100 companies have reported. 72% have beat earnings forecasts and only two-thirds have beat revenue forecasts. Those percentages are the lowest over the last six quarters of reports. But it is early yet, and many big names have yet to report. The 104 S&P names reporting this week lean heavily toward industrials. IBM, Halliburton, GE, Johnson & Johnson, American Express and Tesla are on the docket. 

Wrap-Up

The strong level of the leading indicators index suggests solid economic growth ahead. Not great, just solid. Omicron may stick around in the form of foreign port shutdowns, adding to supply chain woes. Intel’s announcement of a new $20 billion chip factory in Ohio is but one example of a growing re-shoring movement. 

December economic data ramps up this week. Headliners include Consumer Expectations, New Home Sales, Durable Goods Orders, Q4 GDP, Pending Home Sales, Employment Cost Index, Personal Consumption Expenditures, and UofM Consumer Sentiment. The Federal Open Market Committee (FOMC) announcement on Wednesday will dwarf all other data. Traders are waiting for new Fed magic to slow inflation, while keeping the economy running strongly. We will stay in the TLTF2 camp for now.


Steve Orr is the Executive Vice President and Chief Investment Officer for Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary’s University School of Law. Follow him on Twitter here. Mark Frears is an Investment Advisor at Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Science from The University of Washington, and an MBA from University of Texas - Dallas.

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