On a week where there was little change in broader market themes, we saw some notable moves “under the hood” in equity markets. At a broader index level, market moves were fairly moderate, with the MSCI World Index closing the week down just 0.1%.1 There was a continuation of themes from the previous week, with the main market driver being the apparent shift in monetary policy sentiment within the central banks. With that, the rotation continued last week as growth stocks sold off and value stocks continued their recovery.
Concerns over the extent of the Federal Reserve’s (Fed’s) upcoming rate tightening cycle continue to be the main driver behind this price action. Last week’s US December Consumer Price Index (CPI) print didn’t dampen those concerns, coming in broadly in line with consensus, up 7% year-on-year and at the highest level in 39 years. Regionally, the European Stoxx 600 Index lost 1%, the S&P 500 Index was down 0.3%, whilst the MSCI Asia Pacific Index, the underperforming region last year, was up 1.6%.2
There has been a clear focus on central bank rhetoric at the start of the new year, with investors wary of the speed and extent to which monetary policy will begin to tighten. The key focus last week was on the CPI print out of the United States, which came in at the highest level since June 1982. The print set the tone for Fed speak last week, which was unsurprisingly hawkish as a result.
Fed Governor Christopher Waller agreed with consensus that three rate hikes in 2022 is a “good baseline” if inflation stays high, but indicated that he could see potential for four or maybe five rate hikes. Chicago Fed Bank President Charles Evans and Philadelphia’s Patrick Harker echoed those sentiments, saying that three or four hikes will be needed. Governor Lael Brainard added to the many voices calling for a rate hike as early as March. However, Chair Jerome Powell did say the Fed will continue to “use our tools to support the economy”. Yet, he also added that the Fed balance sheet is far larger than it needs to be, adding that it will be run down sooner and faster than the last cycle. Fed speakers have now gone into a black-out period ahead of its 26 January meeting.
The European Central Bank (ECB) continued to do its best to remain dovish in testing circumstances as President Christine Lagarde reiterated the ECB’s commitment to price stability. However, as energy prices continue to spike in Europe, this position is being made more and more difficult to defend. German Bundesbank Chair Joachim Nagel argued that there is a risk of elevated inflation for longer, and the ECB must act if the inflation outlook warrants tighter policy. Yet, the ECB’s chief economist, Philip Lane, tried to de-emphasise the latest inflation data, saying he did not think the criteria will be met for a rate hike this year.
The focus on central bank rhetoric has driven some significant moves in equity markets in the first two weeks of the year. Sector dispersion has been huge in each region. In Europe, year-to-date sector dispersion between best and worst already stands at 16%. The banks, driven by a better rate environment, are now up 10.1% so far this year. Meanwhile, with some of last year’s winners having been sold to fund the move, health care stocks in Europe are down 5.9% over the same time period. Dispersion is even more extreme in the United States. Energy stocks there are up 16.4%, boosted by rising commodity prices, with West Texas Intermediate (WTI) crude oil notably up 12% year-to-date. At the other end, real estate investment trusts (REIT), a 2021 winner and a yield play, have lagged and are down 6.8% so far this year. It is a similar story in Asia; energy stocks are up whilst health care stocks are down, giving sector dispersion between best and worst of 13%.
Despite the hefty moves in bond yields the previous week, last week’s moves were fairly subdued. The US 10-year Treasury yield was up 2.3 basis points (bps) and the German 10-year yield was down just 0.2% bps.3
The question remains for investors: how long will this rotation continue? Central banks are desperately trying to manage expectations into what is going to be an interesting period for monetary policy change. The Fed will likely be the clear focus for investors and with the ECB maintaining its dovish stance, there is significant room for a surprise should inflationary pressures continue, and we could see a more hawkish shift.
Week in Review
The factor rotation continued in European equity markets, with value stocks adding another 7% last week (the Morgan Stanley European Value Index is now up 17.5% year-to-date).4 Hedge funds drove most of last week’s moves, so it was interesting to see the rotation trade continue with long-only investors becoming more active. Market volumes were higher last week, reverting to averages last seen in the second half of 2021. In terms of broader themes, the key focus for markets remains on the Fed’s apparent hawkish shift in the last month. Growth stocks were sold again last week, now down nine out of ten days this year, and so the European Stoxx 600 Index closed the week down 1.1%.
The UK FTSE 100 Index outperformed over the course of last week, up 0.8%, given its weighting in value stocks. Defensive stocks were sold again in favour of more cyclical names. Last week, European stocks saw large investor inflows, helped by the factor rotation. Europe is frequently seen as a proxy for the value factor. It hasn’t all been plane sailing for European capital markets so far this year though.
The factor rotation drove the high-level sector moves last week. Oil and gas stocks were strong, and are finally back at pre-pandemic levels with oil prices fairly resilient. Investors have bought into the rate trajectory and the bank stocks were strong again, despite slightly lower yields in Europe. Basic resources were another notable winner last week as commodities strengthened. The other notable winner was travel and leisure as the COVID-19 picture has improved in Europe. Industrials lagged last week, with growth stocks dragging the sector lower. Personal and household goods were also weaker, with expensive consumer-facing stocks weighing on sentiment. Finally, to complete that theme, retail stocks were also lower, as hedge funds sold the outperformers.
Oil prices were up 6.2% last week as the North Atlantic Treaty Organization (NATO) warned of potential conflict as talks with Russia over Ukraine failed to find a resolution. Russia’s flow of gas to Europe via Ukraine remains at low levels and has the potential to add to concerns about on inflationary pressures due to rising energy prices.
We did see a rise in political risk in the United Kingdom last week, with Prime Minister Boris Johnson coming under heavy scrutiny for attending a garden party at Downing Street during a time of severe lockdown restrictions throughout the country. Some Conservative party members have joined opposition calls for Johnson to resign as his popularity drops. The Conservatives are now firmly behind Labour in the opinion polls, which will also be playing on the minds on the Conservative party. Chancellor Rishi Sunak would be a popular choice to replace Johnson, should he decide to step down. It’s likely that Sunak would pursue roughly similar policies, but in a less erratic fashion. Yet, Johnson is a seasoned fighter so it is unlikely he will step down of his own accord.
US equities saw a choppy week in terms of performance as familiar themes of hawkish Fed speak and inflationary concerns buffeted investors. With that, the S&P 500 Index was down 0.3% last week and ended the week just below its 50-day moving average—recall this has been a recent support level.
Energy markets were a talking point, with WTI crude surging back towards multi-year highs, up 6.2% at US$83.82 per barrel. The move was driven by a combination of tensions between the West and Russia, and a larger-than-expected draw in US inventories. It was no surprise to see the energy sector the best-performing sector, up 5.2% on-the-week and now up year-to-date. The sector laggards were yield plays such as REITs and utilities.
Corporate earnings season is upon us once again, with some of the US banks reporting fourth quarter earnings last week. Both JP Morgan and Citibank disappointed investors on Friday. On the flip side, Wells Fargo performed well thanks to positive earnings.
Looking to macro data beyond the CPI print, we had December retail sales that were weaker than expected. US retail sales fell 1.9% in December month-on-month. This is the biggest drop since February 2021. Reasons suggested for the slump in retail sales include the Omicron variant impact, inflationary pressures, the end of government’s pandemic-related financial programmes, and declines in the savings built up through the pandemic. US consumer borrowing has increased sharply, suggesting individuals are now increasingly relying on credit over savings.
Asia and Pacific
Asian markets were mixed last week with Japan closing the week down 1.24% and China also down1.63%. However, Hong Kong finished the week up 3.79%.
In Japan, concerns about more aggressive monetary policy tightening by the US Fed continued to weigh on sentiment, leading to a similar rotation we saw in Europe and the United States. Confidence was also dented by the government extending the ban on nonresident foreigners entering Japan until the end of February, as well as an apparent sixth wave of the coronavirus hitting Tokyo. The more hawkish Fed contrasts with the dovish stance of the Bank of Japan, which continues to signal its commitment to monetary easing and is unlikely to raise short-term interest rates anytime soon.
The Shanghai Composite Index closed the week down 1.6%, weighed on by headlines about refinancing difficulties in the country’s troubled property sector. China’s largest banks have grown more selective about funding real estate projects by local government financing vehicles, while several developers scrambled to obtain creditors’ consent for maturity extensions and exchange offers. Other developers have intensified fundraising campaigns as traditional financing routes like presales have dried up.
Evergrande, the world’s most indebted property company, secured a crucial approval from onshore bondholders to delay payments on one of its bonds. Reuters reported that Shimao Group, which missed payment on a US$101 million trust loan earlier this month, will meet with creditors to vote on payment extension proposals after denying reports of a fire sale.5 Credit rating agencies Moody’s and S&P downgraded their ratings on Shimao again last week, and S&P said it withdrew its rating at the company’s request.
In economic news, consumer and producer price inflation slowed more than expected in December, while new bank lending fell more than expected. China’s trade surplus rose to a record US$676.43 billion in 2021, the highest since 1950, when the country began recording data. The moderating inflation signs raised expectations that China’s policymakers would lower interest rates and possibly the required reserve ratio for banks to bolster the economy. Any easing in China would mark a divergence with policy in the United States., where Fed officials have telegraphed the central bank’s intention to raise interest rates several times this year to curb a surge in inflation.
On the pandemic front, China suspended dozens of international flights and issued more restrictions in response to the global surge in omicron cases. Hong Kong, which had reported no local infections for months, reimposed some social and travel restrictions after a string of positive cases, dealing a setback to the city’s reopening hopes. Shanghai curbed tourist activity as it rushed to head off local infections as imported cases rose.
Monday 17 January: US (Martin Luther King Day)
Macro Week Ahead Highlights
Monday 17 January
- Norway trade balance
- Switzerland total sight deposits
Tuesday 18 January
- UK labour market statistics
- Eurozone EU27 new car registrations
- Italy trade balance EU
- Germany ZEW Survey current situation
Wednesday 19 January
- UK CPI inflation
- Germany CPI
- Switzerland producer and import prices
- Italy current account balance
- Eurozone construction output
Thursday 20 January
- Euro area final CPI inflation
- European central bank monetary policy accounts
- Netherlands unemployment rate
- Germany Producer Price Index
- France manufacturing confidence
- Spain trade balance
- US weekly jobless claims
Friday 21 January
- UK retail sales
- UK consumer confidence
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5. Source: Reuters, “Chinese developer Shimao to hold creditor meetings to vote on ABS payment extension – documents”, 13 January 2022.