What is up today? 1-24-2022

The VIX index is above 30 as risky assets dropped, safe haven assets like gold rose, yields on US Treasuries are marginally lower, and Swiss Franc appreciated to its highest level against the euro in over six years. The risk off sentiment seems driven by a combination of events.

·       First, inflationary pressures in the U.S. are weighing on real income and in turn on demand with retail sales ex-auto and gas contracting 2.5% in December. There is some risk that the rate increases from the Fed could dampen demand and cause the U.S. economy to go into a recession by aggravating the demand shock.  

·       Second, the global impact of omicron. Companies are citing worsening labor and supply chain concerns with COVID case spikes, workers out sick and trucker shortages. In certain environments, this could lead to increasing supply constraints and inflationary pressures.

·       Third, the marked slowdown in China could contribute to dampen global supply and demand. However, weaker U.S demand may provide supply chains the breathing room they need to reduce bottlenecks.

·       Last, rising tensions between Russia and other nations over Ukraine could prolong Europe’s energy crisis and add economic risk to the region. The impact on the Energy market and the unknown is spooking markets.

About 1/3 of the S&P companies are reporting Q4 earnings this week. Depending on how earnings go, growth stocks with weak fundamentals could further sell off in the current environment. On the other hand, earnings from cyclical companies will give us better reads on Omicron’s impact, wage pressures, supply chain issues, demand pressures, and China.

On the European front, so far this year euro stocks have been more resilient than U.S. stocks thanks to more attractive valuations in particular in France and Italy. However, Eurozone PMIs edged lower in January for the second month in a row and is now almost 8 points lower than its peak in July last year. European economies benefit from lower rates than their U.S. counterparts which translates to lower valuations, although the persistently high energy costs and the new geopolitical uncertainty in the region could dampen sentiment in the near term.

In the current macro backdrop, typical of late business cycle, we believe the most vulnerable growth companies are those with weaker balance sheets reliant on the whims of the capital markets. Market participants are more selective with a focus on valuations, fundamentals, and quality. Margins are expected to remain a key focal area as we wait for more earning updates this week.

With that, in our outlook piece, we indicated that in 2022, the market would pay closer attention to fundamentals and be more selective, clearly that is happening.