The market had a sideways week as multiple sources of uncertainty continue to weigh on investors. Despite reasons for uncertainty, bullish sentiment rose dramatically this week. A bumper jobs report was released on Friday which saw the US unemployment rate fall to levels not seen since before the pandemic. President Biden also ordered the largest release in the history of the Strategic Petroleum Reserve. The White House has ordered a release of about 180 million barrels of oil which will bring the emergency reserve to its lowest level since 1984. When politicians start taking cosmetic actions to appease consumers on inflation, it is a good time to pay attention. For most of the last decades, inflation has been abnormally low. However, prior to globalization, it was a much bigger political issue that can be a bane to incumbents. It appears President Biden is trying to get ahead of what will likely be a big issue in upcoming elections. Our Head of Research, Tom Lee, has done some recent work on how these releases often end up being
counterproductive. On the bright side, the White House is also trying to get domestic producers to up production, which should be more effective than even the largest release in history.
Despite some hopes for peace talks this week, the war in Ukraine rages on. It expanded today as Ukrainian helicopters conducted a successful attack on a fuel depot inside Russia. Earlier in the week, Russian forces began pulling out of Kyiv and back into Belarus. While Russia has said this was an effort to provide good faith in negotiations, most analysts believe the battered Russian forces are pulling out because of their strategic failure rather than any desire for peace. Many believe Russia will refocus its efforts on making territorial gains in the Eastern part of Ukraine, including the embattled breakaway regions. Ukrainian combat forces in this area are their best equipped and most experienced and Russian efforts to redeploy forces may be aimed at enveloping the most competent components of Ukraine’s motivated and emboldened military.
Inflation is making its way into stickier components that affect the consumer wallet, like shelter. This can be problematic if it remains sustained for obvious reasons, particularly when inflation for basic items like fuel and energy continues to be elevated. One difficult item to track when assessing housing inflation is how much the demand curve was changed by the realities of COVID-19. For example, the National Association of Homebuilders has found that YoY demand for apartments in rural areas is up almost 90%. Will this be a permanent trend, or is it one that will subside as COVID-19 hopefully subsides? Suburban rents, similarly, are up a whopping 115% since pre-COVID says housing site Zillow. Conversely, in urban areas, the gains are much more modest. Demand increases are much lower. Rents are also up only 5% from pre-COVID levels in urban areas.
One trend you could set your clock to before the pandemic was that we lived in an “urbanizing world.” Many cities are now seeing their best and brightest flock to previously inconsequential MSAs. Young and active workers seem to be gravitating toward places like Austin, Salt Lake City, Phoenix, and a variety of locales in Florida. At the same time, cities like New York, Los Angeles, Boston, and San Francisco experienced sharp reductions in population over 2021. Whether this trend is an enduring one, or whether we revert to an urbanizing world will be something only truly understood with the passage of time.
One thing is clear from the current uncertainty in the world. The United States and Latin American markets have been performing better than most of the world. For obvious reasons, Europe has been most adversely affected by the ongoing conflict in Ukraine and is currently wholly dependent on Russian energy. While the United States is making efforts to increase natural gas exports to the continent, this is simply not a process that can occur overnight.
Regardless of what happens in Ukraine, the markets will still have to contend with the beginning of the most perilous Fed tightening cycle in modern history. Two weeks after lift-off has begun, nearly every Fed governor has come out and given tangential support to the idea of a more aggressive rate hike schedule, including the distinct possibility of 50 bps hikes. The fixed income markets are already pricing in such an eventuality, and as of market close on Friday, Fed Funds Futures were pricing in nearly a 75% chance that the FOMC will hike by 50 bps in May. The futures price in that their benchmark will be above neutral, at 2.75% by January 2023. This is obviously much more aggressive than Fed officials suggested when they were still sticking to the transitory narrative.
The first quarter of 2022 has most certainly been a wild one. However, the S&P 500 is up significantly since Russia’s invasion of Ukraine rocked a world accustomed to peace. Our Head of Research, Tom Lee, told you prior to the invasion that the strategy of “selling the run-up and buying the invasion,” was supported in similar historical circumstances. Well, that strategy proved very useful, and the market bottomed exactly on the day of the invasion. We understand that markets have been tough, and we also understand that the risks faced for markets and the world are no laughing matter and could very well result in significantly more downside.
Still, we are finding it more and more probable that we have already made the bottom for the first half of 2022, and like we have been saying for some time now, we expect the second half of the year to be much more amenable to equity investors. The new topic of the day to freak out about is inflation as the terrible conflict in Ukraine becomes tragically normalized. There are reasons we think investors may not be understanding the interplay between ‘episodic’ inflationary drivers and the yield curve. Our Head of Research, Tom Lee, will explain why investors may not be getting the whole picture from the brief inversion of the yield curve below.
