Stocks snap losing streak, but will it be sustained?

Major global indices rose on Monday and the Vix retreated back to the 24 level, as markets ended what has been a dismal month for stocks on a high. The Nasdaq led the gains higher for the second straight session, rising 3.4%, with the S&P 500 up more than 1.8%. The outperformance of the Nasdaq has helped it to claw back some losses after a weak start to the year, however, the tech index remains 9% lower YTD. Is this move a squaring up of positions as we end the first month of the year, or could it be a sign that the growth vs. value trade might be roaring back to life? 

To put the January moves into some context, value and international stocks surged last month, while growth and memes sunk. The S&P 500 energy sector jumped more than 18% so far this year, while GameStop, everyone’s favourite meme stock in 2021, sunk more than 26%. Likewise, while the Russell 2000 fell some 9.7% in January, the MSCI index was roughly stable, falling a touch at -0.02%. But will this continue? A lot will depend on the economic data that we see this week, and any shift that it causes to expectations of Federal Reserve rate hikes. Currently the financial markets are pricing in 5 rate hikes this year, with banks including Goldman Sachs expecting the Fed Funds Rate to end the year at 1.25-1.5%. The terminal rate, the end of the Fed’s hiking cycle, is expected to come in 2024, when the Fed Funds Rate could be as high as 2.5-2.75%. Combined with balance sheet reduction that Goldman analysts now expect to begin this June, this is considered to be an aggressive pace of tightening, however, the Fed’s terminal rate has not been drastically changed. US interest rates were expected to climb to more than 2.5%, however, the rates have been front-loaded. But is there a risk to this view and what does it mean for markets? Below, we take a look at three events this week that could impact  US rate expectations and we de-code what this means for asset prices. 

1, Earnings season 

This is a crucial week for US earnings, with a raft of big tech and value names reporting Q4 results, including Alphabet, Amazon and Meta Platforms. What’s been interesting since the start of the year is that earnings expectations have remained steady throughout the January sell off. This is a sign that stocks have sold off because valuations were too rich, not because investors are worried about a significant slide in global growth and thus, corporate earnings in the months ahead. FactSet, the data gatherer, has calculated that the Q4 net profit margin for S&P 500 companies, including those companies that have reported results and the expected results for those who are still waiting to release their earnings figures, is 12%. This is higher than a year ago and it is also higher than the 5-year average that comes in at 11%, however, it is lower than Q3 2021, when the net profit margin was 12.9%. Interestingly, energy and technology are the only sectors that are expected to report an increase in their net profit margin in Q4 2021 relative to Q3 2021, yet tech has been one of the worst performing sectors so far this year. The impact of inflation is starting to bite, which is why only these two sectors managed to beat their Q3 net profit margins. Analysts expect the impact of inflation to be temporary, and for net profit margins to increase over the coming quarters, with estimates for Q1 2022, Q2 and Q3 at 12.4%, 12.7% and 13% respectively. What does this tell us about where stocks can go next? If analysts are confident that profit margins will pick up and firms will only be temporarily impacted by inflation, then it could be time to buy the dip, and a stock market recovery could be on the cards. Thus, the outperformance of the Nasdaq on Monday, could be a taste of things to come, although it may not be plain sailing this week. 

2, US economic data 

There is a raft of economic data from the US to wade through this week. We think that the key releases will be the prices paid component of the ISM indices for January that will be released on Tuesday and Thursday. Both of these sub-indices are expected to move higher, with the manufacturing ISM prices paid component expected to jump to 79.5 vs. 68.2 in December, mostly as a result of a surge in the price of oil. The service sector prices paid component is expected to remain at elevated levels, 83 is expected up from 82.5. Thus, the inflationary impulse remains, and this could reinforce the Fed’s hawkish stance. We know that markets have been incredibly sensitive to inflation pressures in the US recently, thus any upside surprises from these already high levels could trigger volatility to rise once more. 

Complicating the picture, is the real possibility that payrolls could turn negative for January as a result of bad weather and the surge in Omicron infections. The average analyst estimate is for a reading of 155k for January’s NFPs, however, there are a number of analysts who are calling for a negative number. We think that on balance the number will be in positive territory, largely because the employment component of the service sector ISM is expected to rise for last month, however, jobs in other parts of the economy may have fallen back and there could be some variability between states. If we do get a negative NFP report for January, we think that the Fed will choose to see it as a one-off blip and stick to their hawkish guns. Thus, economic data may not be too supportive of stocks as we progress through the week. 

3, Central banks and FX 

The FX market has been ahead of the game when it comes to pricing in a hawkish Fed. The dollar has surged since the second half of 2021, although it has recently fallen back. The dollar index is currently trading at 96.65, a drop of more 0.5% at the start of the week. Could the dollar be telling us something? Has the market got ahead of itself pricing in a hawkish Fed? Will the Fed actually be less hawkish than we expect over the course of this year? If yes, then this could be dollar negative, and we think that the market is repricing the dollar to take account of this scenario. Thus, we could see a mild dollar sell off in the next few days as the market assesses the latest US economic data. 

The Bank of England and the ECB both hold meetings this week and the BOE is expected to bite the bullet and hike interest rates by 0.25% to 0.5%. This would be their second rate hike in two meetings, the vote to hike is expected to be unanimous. We don’t think that this meeting will change our view that UK rates will reach 1.5% by Spring 2023, however, there is one variable that could scupper this estimate: Ukraine. The surge in energy prices, the Brent crude oil price has pulled back from $90 but it remains elevated, is a key driver of UK inflation fears right now. This, along with surging natural gas prices is triggering fears about a continued increase in prices, especially with the end of the energy price cap in April. However, if Ukraine tensions start to reduce in the coming weeks - we do not believe that Putin will actually invade at this time - then geopolitical issues could do the heavy lifting for the BOE, since energy is such a large part of the UK’s inflation story. 

This leads us to the ECB, although it is expected to remain in dovish mode for now, we do expect Lagarde to acknowledge price pressures without hinting when rate rises are coming. The ECB is still purchasing assets, and even though they have not hinted that rates will rise, the market has priced in one rate increase by the end of this year. There is a risk that the market is too optimistic on this, especially as Eurozone inflation for January is expected to moderate from 5% to 4.3%, with the core rate also expected to moderate to 1.9% from 2.6%. This hardly demands urgent action from the ECB, especially since Lagarde has been clear that she cannot control energy prices that are driven by international factors. Thus, we think that the ECB’s stance will continue to weigh on the euro, even if the euro staged an impressive comeback on Monday. EUR/USD is in our sights this week, and the medium-term technical indicators for this pair are still negative. As long as EUR/USD remains below its 100-day ema at $1.14, then we think this week’s ECB meeting could trigger another leg lower for EUR/USD, with $1.10 a key support zone.