Market Forecast For the Week of February 7, 2022: A Respite From Volatility Before A Short Deluge Next Week
FORECAST: The S&P 500 consolidates last week’s gains as a better than feared earnings season gives the bulls reason to hold onto the gains since the January 24 bottom. But I don’t see the bulls taking the market back to the January 4 all-time high as growing geopolitical fears keep volumes low. By next week the bears will retake control and take the markets to a retest of that bottom by the middle of February.
While corporate revenues are beating estimates at a historically strong rate, that backward-looking happy event contrasts with corporate guidance that high downstream inflation and tight labor markets threaten future profit margins. Rising geopolitical and policy risks will amplify these financial concerns and cause a retest of the 4200 region for the S&P 500. The primary risks include whether China is really making a huge mistake in its zero-COVID policy, and whether statism is rising inexorably and a harbinger of lower dynamism and more geopolitical conflicts. The political impact of COVID contributes to these fears since in several cases leaders have lost the confidence of the public as their nations moved leftward. With issues like climate change, inequality, immigration and social justice dominating public discussion without any policy consensus on how to solve them, the likely result in more statism, as has been seen in Mexico, India, Turkey and now in Chile and Germany. And rising statism corresponds to the strict Chinese COVID policy, which despite its cruelty has yet to cost Xi Jinping any drop in public support. Statism in turn threatens businesses and shareholders, resurrecting memories of 1970s dysfunction and the lost decade of poor stock market performance.
Whether this pessimism persists through 2022 or gives way to bullish optimism depends on the path of COVID, which is uncertain until herd immunity is reached. I expect the pessimism to evaporate by late February due to the clear strength of American businesses and the American consumer in getting back to normal. The labor market is so strong despite Omicron that profit margins likely remain level as more workers join the active labor force. The bullish trends in commodities in the face of rising interest rates and a rising $US lend support to this. And while equity valuations look rich as the yield curve moves higher toward pre-pandemic levels, real rates are likely to peak at zero since US inflation expectations are tethered to 2%, implying the Fed will not actually get rates back to 2019 levels, and that will keep equities as the preferred asset class.
Financial risk remains a concern but dollar shortages have eased. While China’s property crisis hasn’t triggered any fallout among global banks yet, cross-border bank claims to the non-financial private sector (e.g., real estate) are high according to the most recent BIS data. So the global financial markets need the Chinese Communist Party to finesse the troubles at Evergrande et al, which the CCP is incentivized to do since Chinese retail investors have money at stake. But overall the most recent BIS data shows aggregate cross-border bank claims are rising at a modest 3% clip (based on increase in Q3 2021 of $228 billion), indicating contagion risk remains a modest concern. EM debt repayment remains murky for badly run nations (e.g., Turkey, Argentina) but moderate global growth is buoying export confidence in major EMs. Fortunately there has been no major chatter regarding concentration risk or counterparty risk at large financial institutions.
On Friday I sold my position in American Express (AXP). My other current positions include a sizable cash position, Amgen (AMGN), Goldman Sachs (GS), Johnson & Johnson (JNJ), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), Titan Machinery (TITN) and the levered ETF UPRO.