Major economic releases during the month of January showed that the economy grew at a robust pace to finish the year and inflation remains stubbornly high.
Starting with the broad economy, Real Gross Domestic Product (GDP) – the broadest measure of goods and services produced, adjusted for inflation – grew at a 6.9% annual rate in the fourth quarter. This was ahead of the consensus expectation of 5.5%. As a result, real GDP was up 5.5% for all of 2021. The last time the economy grew that fast was 1984, during President Ronald Reagan’s first term. On the surface, growth of nearly 7% on an inflation-adjusted basis is very strong. However, reading into the sustainability of that growth there is some cause for concern. Most of the growth came from a faster pace of inventory accumulation as businesses seek to shore-up from the shortages that have been experienced during the past year. Excluding the impact of inventory accumulation, output was a more modest 1.9% during the quarter.
Inflation in the U.S. hit its fastest pace in decades. The consumer price index (CPI), which measures what consumers pay for goods and services, rose by 7% in December from a year earlier. That is the highest since 1982 and was the third straight month where inflation exceeded 6%. A separate report from the Labor Department also showed that while workers are seeing pay increases in the face of a tight labor market, they aren’t keeping up with the headline rate of inflation. On average, wages are up by 4.7% over the past year.
The Stock Market
January was the worst month for the market since March 2020 with the S&P 500 retreating by over 5%. On the heels of a strong finish to 2021, stocks came under pressure in the new year as investors turned their focus to the timing of the Federal Reserve’s decision to begin raising short-term interest rates in order to combat inflation, the economic effects of the latest Covid surge, and increasing Ukraine and Russian border tensions. Technology stocks, which make-up the largest weighting in the market, suffered some of the biggest losses. The Nasdaq composite fell 9% in January, also it’s largest one-month loss since March of 2020. Mid- and small-cap stocks were also impacted by the sell-off.
The decline in the Dow Jones Industrial Average during the month was less severe than the other major market benchmarks. Emerging market stocks declined the least in January, however they continue to be the weakest area of the equity market over the past 12 months.
Energy was the only sector to post a gain in January, up an impressive 19.1%, driven by the continued rise in oil prices.
Source: Bloomberg Finance, L.P.
In the coming weeks investors will likely turn their focus to company earnings as the bulk of S&P 500 stocks have yet to report for the fourth quarter. FactSet currently estimates Q4 growth of 24.3%, which will be the fourth straight quarter of earnings growth above 20%. As the focus turns to 2022, analysts expect earnings growth to moderate to 9.5%. Although down from recent trends, this would still mark relatively robust growth.
With the recent decline in the market combined with slightly higher earnings estimates, the forward-looking price-to-earnings (P/E) ratio of the S&P 500 now stands at 19.2x compared to 21.3x as of December 31st.
Fixed Income
Source: J.P. Morgan Guide to the Markets, January 31, 2021
The Federal Reserve left interest rates unchanged following their January meeting but signaled they will likely raise interest rates and end their asset purchase program by March as they begin to move away from the pandemic-era accommodations that have been in place for nearly two years. Several economic releases during the month continue to point toward inflation running at multi-decade highs. The last time the Fed embarked on a tightening cycle was in December 2015. At that time inflation was running between one and two percent and the Fed was very gradual in raising rates, hiking only once during the first year. Today, inflation has been running north of six percent. Most strategists expect four or five rate hikes in 2022, followed by another two or three in 2023, and eventually reaching a terminal Fed Funds target of 2.5-2.75% in 2024.
Conclusion
The market action in the month of January was another reminder that markets will experience periods of volatility and drawdowns. While it is never fun to see portfolio values decline it is very “normal” for periods like this to occur. From the beginning of 2019 through the end of 2021 the S&P 500 returned over 100%, including reinvested dividends, and a portion of that period included the massive sell-off in March of 2020 when the S&P declined by over 34%. Short-term volatility is the price investors pay for the opportunity to participate in the compounding markets deliver over the long-term.
