- Russian invasion of Ukraine causes commodities to climb sharply
- Inflation pressure persists with new data coming in hotter than anticipated
- Federal Reserve rate hike odds settled in at one 25bps rate hike in March
- US 2Y10Y spread flattens 21bps
- 76% of S&P 500 companies reported positive earnings surprises for 4Q21
To say February was a tumultuous ride would be quite an understatement, with what seemingly was routine +/- 2% moves in the broader indices daily. The month started on a positive note, piggybacking off the late January rally as investors remained skeptical of a 50bps interest rate hike at the March FOMC meeting. The early rally quickly faded, though, as January CPI data came in hotter than expected, with annualized headline inflation at the highest levels since February 1982 and core inflation at its highest since August 1982. With the hot inflation print came renewed calls from some Fed officials for a 50 bps rate hike at the March meeting – further dampening prospects for growth stocks. Just as the market appeared to come to terms with the potential of a >25bps rate hike, the focus began to shift to geopolitics as headlines were dominated by the Ukraine crisis and what we now know was the actual precursor to a Russian invasion. Markets sank on the news of the invasion but quickly rallied back after sanctions were initially seen to be less severe than expected. After fighting picked up over the final weekend of the month, harsher sanctions were introduced, including removing some Russian banks from the SWIFT network and freezing Russian central bank assets held in the United States.
Outside of the Federal Reserve and geopolitical headwinds, February also saw the back half of 4Q ’21 earnings prints. Though net profit margins remain at near records, companies continued to report margin headwinds from wage growth and supply chain pressures, dampening expectations for future earnings growth.
On a total return basis, Micro and small caps were the top performers over the month, while large-cap growth stocks took the brunt of the pain. At the sector level, Energy stocks were by far the best performers, finishing up 7.1% - the only sector to close in the green. Communications stocks were the worst performers finishing down 7%, followed by REITs, Technology, and Consumer Discretionary, which were all down between 4-5%.
The Bloomberg Commodity (BCOM) index notched new highs in February, finishing up 6%. Gold futures – which carry a 14.25% weighting in the index – climbed throughout the month finishing higher by 6.2%. Brent Crude futures jumped 10.7% when international sanctions on Russia followed the Ukraine invasion, while WTI rose 8.7%. Aluminum jumped over 11%. Huge gains were seen in the Wheat market (~18%) as Russia is the world’s largest exporter. Russia and Ukraine combined account for nearly 26% of the world’s total wheat exports as of 2020.
CPI Inflation – YoY:
CPI Inflation – MoM:
With almost 96% of companies having reported fourth-quarter earnings, we have seen 76% of companies report positive earnings surprises, with an average beat of just under 6%. On the growth front, 77% of companies have reported earnings growth, with an average growth of 30.25% - the fourth straight quarter of earnings growth above 30% and better than the 21% growth expected at the beginning of the quarter.
This year, earnings are expected to slow, however, with 8.6% earnings growth expected for the full year compared to about 48% in 2021. Q4 revenue figures haven’t been quite up to par with earnings as just over 69% of companies reported positive sales surprises, with an average beat of ~4.5%. The 69% reported sales surprise is slightly the 5-year average of 68%, while the beat is above the 5-year average of 1.5% per Factset.
Technology companies led the way in terms of earnings surprises with 87% beating estimates, followed by Real Estate (82%), Health Care (81%), and Financials (80%). Financials had the second-largest average beat with just under 12%, while Consumer Discretionary names led the way with an average beat of just under 13%. On the earnings growth front, Industrials and Materials companies stayed ahead of the pack after reporting 103% and 57% growth, respectively.
The forward 12-month PE for the S&P 500 is 18.8, which is slightly above the five (18.6) and 10-year (16.7) averages.
In terms of price action following earnings prints, Consumer Staples stocks saw the biggest positive 2-day move, climbing an average of 2.1%, followed by Real Estate at 1.0%, Healthcare at 0.3%, and Basic Materials at 0.1%. All the remaining sectors saw negative 2-day price action. Communications stocks took the brunt of the pain with an average slide of (2.3%), followed by Industrials (1.6%) and Financials (1.6%).
The 2YR10YR spread continued to narrow during February as 2YR yields climbed to levels not seen since the start of the pandemic. With the 2YR10YR spread now down below 38 basis points due largely to the upward velocity in the 2YR yield, investors are worried the Fed is increasing rates as the economy loses steam. There is still some room before a yield curve inversion, and even then, a recession typically comes with a lag, but it is a concerning signal nonetheless. At month’s end, the market is pricing in one 25bps rate hike in March and a total of five by the end of 2022. It should be noted that the market had been pricing in as many as seven rate hikes in 2022 in Mid-February.
US 2YR Yield:
US 10YR Yields:
US 30YR Yields:
The crypto universe seemed to have found its footing in February as the slide from the November highs halted. Bitcoin traded in range between ~37k-44.5k while Ethereum mostly stayed between 2.6k-3.2k. While the inflation hedge narrative for cryptocurrencies hasn’t fared well over the past few months, crypto’s did see a boost as new sanctions were imposed on Russia, including removing some banks from the SWIFT network and banning payments from Russia to foreigners. As Russians were struggling to remove their plunging Rubles from their banks, speculators assumed the demand for crypto assets would surge as Russians looked for alternatives. Although there has been some discussion about using crypto as a way to avoid sanctions, it would likely be very difficult to disguise the sheer size of the transactions that would have to take place on a public blockchain.
There are certainly a number of key events to keep an eye on in March, which could set the stage for the rest of the year. The two primary events will obviously be the continuing war in Ukraine and the FOMC decision, which will be announced on March 16. The market is currently expecting a 25bps rate hike from the committee, but that could change quickly depending on what happens in Ukraine. If we see an escalation overseas, some believe the Fed could pause their rate hike plans, but that would be a shock to the market. Outside of the obvious events, the ever-changing discussion around Covid restrictions seems to be cooling off, so it will be worth monitoring what impact that has on the broader economy. Underlying all of this, as always, will be the pace of the economic recovery, corporate earnings growth and the Fed’s pace of interest rate increases and balance sheet reductions.
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