Goodbye Yellow Brick Road

Feb 28, 2022

By Pete Biebel, Senior Vice President

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Investing is a long-term journey. We all hope for fair weather and smooth roads, but we know that occasionally things can get a little stormy and the path can get a little bumpy. Two years ago, the Covid pandemic caused what had been a very pleasant, years-long expedition to take a sudden and violent detour. Thankfully for investors, it was a very brief interruption and the following 18 months proved to be a very pleasant excursion.

Investors owe a huge debt of gratitude to the Fed for keeping interest rates low for years and for gilding the path forward with their policy of continuing liquidity injections. The world has been awash with money, and that money all had to go somewhere. Yet, everyone knew that flood of funding would come to an end someday. Beginning last fall, as Fed officials provided more detail on their plans for reducing the liquidity injections and eventually raising their target lending rate, the nature of the markets changed. The road ahead, which had been so smooth and well-lit, became much darker and uneven.

Some of the first potholes came in the form of significant deflation in several of the market’s pockets of extreme over-valuation. Non-profitable tech companies, meme stocks, crypto currency-related stocks and others, which had been bid up to very rich valuations by momentum traders in recent years, crashed and burned late last year. The excess liquidity that had helped to fuel the rallies in those stocks is going to soon be in the rear-view mirror.

As 2022 began, the road got rockier. Interest rates were higher, geopolitical risks were heightened and several of the previously leading, seemingly bullet-proof mega-cap stocks were suddenly under pressure. The market’s January slide, which did the most damage to small-caps and tech stocks, bottomed-out about a month ago. Through early-February, the market struggled to get back in gear but recovered only a portion of the January skid. In recent weeks, events in Eastern Europe became more prominent obstacles in the market’s path. Early last week, the averages were careening toward the ditch when news hit that Russian forces had indeed invaded Ukraine. Last Thursday morning, stocks hit a wheel-buster of a pothole.

A couple hundred years ago, a British banker, Nathan Rothschild, allegedly advised traders to “Buy on the sound of the cannons, sell on the sound of the trumpets.” The more modern version of that adage is “Buy when the missiles are in the air.” That advice is based on the tendency of markets to panic at the onset of war, which in turn tends to create good buying opportunities. News of a new war is apt to beget selling, and last Thursday, it begot a lot. And it spawned what turned out to be a great short-term buying opportunity.

On Thursday’s opening, the major averages all plummeted below their January lows to levels they hadn’t seen since last spring. The lows of the day came in the first few minutes of trading. Stocks began recovering immediately, slowly at first, then at a more frenetic pace after the early losses had been recovered. The averages not only steered their way to big gains on the day, but they also drove higher on Friday in an all-day buy-a-thon rally.

For the week, the S&P 500 Index (SPX) gained 0.82%, reducing its year-to-date net loss to 8.00%. The Dow Jones Industrial Average (DJIA) couldn’t quite get back to even, ending with a net loss for the week of 0.06% and widening its YTD loss slightly to 6.27%. The Nasdaq Composite Index (COMP) advanced 1.08%, so its YTD loss now stands at 12.47%. To put some numbers on the late-week gyrations, COMP lost about 3.5% on Thursday’s opening; at its low that morning, COMP was down about 7% for the week. Over the remainder of Thursday and Friday, COMP gained 8.7%.  That’s a great month in less than two days.

It seems reasonable to expect that the road ahead will continue to be bumpy for the next several weeks. Among the obstacles the market will need to navigate are…

– The conflict in Ukraine and its impact on global economic activity with a particular attention paid to…

– The cost of a barrel of crude oil. Energy prices could be the next speedbump for our markets. They are where American consumers and investors will most directly feel any impact from Russia’s action in and around Ukraine. Prices of other commodities such as gold and wheat might also be volatile.

– The next scheduled Fed policy announcement is just over two weeks away. A 25-basis point increase in their target short-term lending rate is almost assured. While a bigger hike of 50-basis points was the odds-on favorite a week ago, the probability of such a large hike has decreased significantly as a result of the Russian invasion.

– The stock market will need to avoid giving back too much of last week’s late-week gains. SPX bottomed last Thursday near 4100 and ended the week near 4400. A little backing and filling could be tolerated but falling back below 4300 would likely be a sign of trouble down the road.

The recent market weakness has been a payoff for investors who resisted spending sideline cash in a very expensive market late last year. Relative bargains now abound. While many individual stocks are much better values now than they were three to six months ago, I believe it would be prudent to resist the urge to buy aggressively now. Some selective buying would be okay; stick to big-name, fundamentally solid companies, especially ones with a history of increasing their dividend payouts. The market is still in the process of determining what valuations will be like in a higher interest rate, Fed tightening environment.

And on a historical basis, our stock market is still quite expensive. The earnings yield of the S&P 500, net of the current level of inflation, is not only now a negative number, but it is also at an all-time low. The ratio of the stock market’s total value to GDP is at a record high. Those fundamental factors suggest there may be more speculative excess still to come out of the market. Stick to quality and value and consider non-traditional, income-oriented funds that specialize in investments such as direct lending and private credit.

Developments in and around the conflict in Ukraine will likely be the primary drivers of market action in the next week or two. Earnings season is winding down. President Biden is scheduled to deliver his State of the Union address tomorrow evening. The release of the Fed’s Beige Book on Wednesday afternoon could provide a hint of the Committee’s most likely action at its meeting two weeks later. The key employment reports come late in the week.

Date Report Previous Consensus
Monday 2/28/2022

Intl. Trade in Goods, Trade Deficit, January



Chicago PMI, February



Dallas Fed Manufacturing Survey, February



Tuesday 3/1/2022 PMI Manufacturing Final, February



ISM Manufacturing Index, February



Construction Spending, January, M/M



Wednesday 3/2/2022 Motor Vehicle Sales, February, SAAR



ADP Employment Report, February, M/M



Fed Beige Book
Thursday 3/3/2022 Initial Jobless Claims



Nonfarm Productivity, Q4, SAAR



Unit Labor Costs, Q4, SAAR



PMI Composite, February


Factory Orders, January, M/M



ISM Services Index, February



Friday 3/4/2022 Nonfarm Payrolls, January, M/M



Unemployment Rate 4.0% 3.9%


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