Wages, Prices, Wages, Prices

By Ben Norris, CFA, Securities Research Analyst, Associate Vice President

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The first quarter of 2022 came to an end last week and stocks saw their worst performance since the beginning of the coronavirus pandemic. For the quarter, the S&P 500 (SPX) was down 4.60% and this was including a rally of 3.71% in March. Similarly, the Dow Jones Industrial Average (DJIA) lost 4.10% in the quarter despite a 2.49% rally in March. The NASDAQ Composite, which is heavily weighted in growth and Technology stocks, got off to a particularly bad start to the year, losing 9.10% even after a 3.41% rally last month. The Russell 2000, a measure of small-cap stocks, lost 7.53% in the first quarter while the Russell Mid-Cap split the difference between small- and large-cap indices, losing 5.68%.

Across sizes, value stocks strongly outperformed their growth stock counterparts as investors favored more cyclical sectors that tend to be classified as value. Notably, the Energy sector has seen historically good performance year-to-date, gaining nearly 40% through last Thursday. For perspective, the next best performing sector was Utilities, which saw a gain of 5.48%. The three worst-performing sectors have been the Communication Services, Consumer Discretionary, and Technology sectors, which have generally been strong performers over the last several years. They saw losses of 10.80%, 9.40%, and 8.86%, respectively. While a weak start to the year is not what many investors hoped for, we should note that the S&P 500 is just 5.55% below its all-time high set on Jan. 3 – not particularly bad, all things considered.

Now we know that stocks have performed relatively poorly so far in 2022. But why? Well for one, the pandemic continues to affect communities and economies around the globe. While conditions have improved since the Omicron variant dominated headlines just a few months ago, the pandemic is still causing disruptions around the world. So, while the pandemic continues, with no true end in sight, its knock-on effects (and policymaker responses) are the true reason markets have been suffering. We’ve often discussed the high levels of inflation being experienced in the U.S. (and in most other major economies) in this recap, and this week is no different. Inflation, in its various forms, has been at historic levels for months and central bankers around the world have finally taken steps to address the issue.

Typically, inflation coincides with an economy that is running too hot. Central bankers are forced to slow economic growth down to avoid inflation getting to a point where it can’t be reined in. They accomplish this by tightening financial conditions and raising interest rates. This current bout of inflation is a bit unique because it was created (at least in part) by policymakers’ response to the pandemic rather than a humming economy. In an effort to avoid an economic crash as the world locked down near the beginning of the pandemic, policymakers flooded the U.S. economy with cash by putting it directly in the hands of consumers. At the same time, the U.S. Federal Reserve cut interest rates in a similar effort to incentivize spending and investment by making it cheaper to borrow money and do business.

These stimulative actions are now being undone in some form or another. The Federal Reserve has raised interest rates so that it is now more expensive to borrow money; the hope is that this will slow the recent run-up in inflation. Unfortunately, investors really like low interest rates. The concern now is that as interest rates are rising (as the Federal Reserve intends) the U.S. economy may actually cool off too much and fall into a recession. This is the latest fear that has investors selling their stocks and is a primary reason that stock performance has been disappointing so far in 2022.

One area that investors should keep a close eye on is the domestic labor market. The U.S. economy has been adding jobs at a torrid pace over the last several months and most employment figures look very strong. Jobless claims are at historic lows, the unemployment rate has returned to pre-pandemic levels, and wage growth has remained strong. However, strong labor figures are somewhat of a double-edged sword in this case. For one, while wage growth has been strong, it hasn’t kept up with strong inflation figures. Similarly, the labor force participation rate, which measures the percentage of workers who are employed or looking for work relative to the total working-age population, has still not returned to pre-pandemic levels. This creates a condition in which businesses struggle to fill open positions and tend to offer higher wages as a result. On the surface this seems like a positive, but when coupled with higher inflation, could cause what some refer to as a wage-price spiral. A wage-price spiral is a theoretical concept in which higher wages cause higher prices, which in turn cause higher inflation, etc. We can’t say for certain if this phenomenon will come to fruition, but the possibility has some investors (and economists) watching data closely. Unfortunately, an easy solution for this situation would be to cool down the labor market – meaning a higher unemployment rate, and an environment where workers are competing for jobs and not the other way around.

This week’s light slate of economic data includes the minutes from the latest Federal Open Market Committee (FOMC) meeting so we may get some insight into how the Fed is viewing some of the issues discussed in today’s blog. Later in the week we get more employment data as well as a few Fed speakers.

Date

Report Previous

Consensus

Monday 4/4/2022

Tuesday 4/5/2022

 ISM Services Index

56.5%

58.0%

 Federal Reserve Speakers

Wednesday 4/6/2022

 Federal Open Market Committee Minutes

Thursday 4/7/2022

 Initial Jobless Claims

202,000

200,000

 Continuing Jobless Claims

1.31M

 Consumer Credit (Feb.)

$7B

$15B

 Federal Reserve Speakers

Friday 4/8/2022

 Wholesale Inventories (Feb.)

2.1%

2.1%

 

Links to previously published commentaries can be found at benjaminfedwards.com/For Our Clients/Educational Resources/Market.