Capital Markets Perspective brings you what to watch in the markets this week, published in partnership with Great-West Investments.
Week in Review
February 14– 20
If you’re like me, your Outlook account was sending President’s Day-themed “out of office” replies on Monday.
But while we were enjoying our long weekend, Russia was busy inventing a brand-new President’s Day celebration all its own when Russian President Vladimir Putin appeared on Russian television alongside the members of his country’s national security council. During that production, council members appeared one-by-one and encouraged the President to officially recognize Ukrainian breakaway regions Luhansk and Donetsk as independent, sovereign areas, something the Russian parliament had already debated weeks before. Russian troops are reportedly already in those disputed regions in the Ukrainian southeast.
Whether or not that represents a prelude to wider war or a fiat accompli all on its own is not yet known, but markets in Europe didn’t wait to find out: the Euro Stoxx 50 – one of the continent’s most popular equity market benchmarks – was down (-2.2%) on Monday while Russia’s RTS was down a whopping (-13.2%), bringing its loss since November, when the crisis was only just starting to grab the world’s attention, to more than (-34%.)
US stock markets reacted, too, even if only via futures markets (which trade more or less continually, even when the so-called “cash market” is shut for annoying things like evenings and holidays.) S&P 500 Index futures fell by as much as 2% from Friday’s levels during Monday’s holiday-stalled, futures-only session, but had recovered at least half of that distance by midday on Tuesday as cooler heads prevailed and the world waited for its answer. So far, that seems like the more rational response.
Of course, that doesn’t mean this whole episode is over – not by a long shot. As I write this, President Biden is addressing the nation and has begun to implement limited economic sanctions against Russia while repeating earlier warnings that more stringent measures will follow if tensions escalate further. Until then, markets seem (wisely) to be taking a wait-and-see approach. (In fact, US equity markets did their best to scramble back toward the line of scrimmage from earlier losses today following the President’s press conference – perhaps out of relief following Biden’s reassurance that the US response would remain economic and not military in nature.)
There is of course an entire laundry list of impacts that could be felt locally by a further escalation of the crisis, starting with oil prices. European crude oil was up 2% on Monday and another 1% (so far) on Tuesday, with US crude prices rising, but so far still playing catch-up. Russia is currently the fourth-largest non-OPEC supplier of oil into the US*, but the global nature of oil markets and the array of potential sources of marginal production in the near- to medium-term means that the relationship between geopolitical stress and oil prices is extremely complex and likely driven by emotion and fear more than by fundamentals. Still, consumers don’t really care why oil prices are rising, and more expensive crude is certainly not something an economy already struggling with the highest rates of inflation in a generation is probably equipped to handle very well.
Then there’s the whole question of sanctions: President Biden has promised a very stiff regime of financial and trade sanctions if Russia crosses the border for real – something US allies have mostly signed on to support (even though some did so somewhat grudgingly.) Like oil prices, the actual impact of sanctions on both the subject country as well as the country imposing them is both complex and unpredictable; suffice to say, though, that aggressive sanctions are probably not a positive development for either country given the current economic environment (and certainly not for Germany, where the proposed NordStream 2 pipeline that would carry more Russian natural gas into a country already significantly dependent on it has become a lynchpin of the western world’s proposed response.)
But in the meantime, the US market’s relatively calm response compared to Monday’s steeper losses in Europe and elsewhere are as good an illustration you’re likely to find of one of the axioms that seasoned market-watchers know (or at least suspect): when dramatic world events occur, it’s sometimes better to be out to lunch as they unfold and let the other guy deal with the knee-jerk increase in volatility. That’s because as tragic as the events in Ukraine already are, US markets are by their nature devoid of empathy and will likely remain focused on what matters most to them: the extent of any economic blowback that’s likely to reach US shores. And that’s something that we simply can’t yet know.
It’s easy to forget about the real, live economy when the focus on geopolitics is so intense, but last week provided more incremental evidence that the US economy remains somewhat in flux. To review, it now seems as if the US economy is struggling with two contradictory forces: inflation and the threat of overheating that it brings on one hand, and a clear cooling off of growth (perhaps eventually leading to contraction or recession) on the other. Last week’s data supports both ideas.
Let’s start with inflation. The headline-grabber was of course Tuesday’s producer price index release, which showed headline inflation at the wholesale level rising by a gasp-worthy 9.7%. But like the January CPI report before it, the actual number probably wasn’t as important as the trend: while both the headline and core readings for PPI were higher than feared, the headline figure was at least a slight deceleration from the previous month’s 9.8%.
And that squares nicely with data from both regional fed manufacturing reports we got last week. On Monday, the New York Fed’s Empire State report showed that while prices remain extremely elevated, they are at least starting to plateau a little bit at the loading dock: prices received by New York area manufacturers continued to rise, but prices paid for raw materials and so forth plateaued near recent highs. Similar noises came from the Philadelphia Fed’s manufacturing report, where prices paid by producers actually declined a little bit while prices received continued to inch higher. The image that comes to mind is the proverbial rat making its way through the proverbial snake: inflation is slowly being digested by producers (like those that respond to the Feds’ Empire State and Philly Fed surveys) and is in the process of being fully digested before making its way out the other end to consumers in the form of higher prices. Sure, it’s still a snake and a rat, but at least the rat is moving.
Which brings us to our final point from last week’s data (also coincidentally from the regional Feds). While the inflation-related insights from both Empire State and Philly Fed were probably the most interesting and impactful things to come from the report, it’s also worth noting that the headline numbers – which try to capture how robustly the manufacturing sectors in their respective regions are growing – were weaker than expected (and in the case of Empire State, was accompanied by a notable weakening of optimism among respondents.) All else equal, that echoes evidence that is becoming increasingly common in other reports designed to look forward that even if economic growth isn’t necessarily at risk for reversing anytime soon, it’s also probably decelerating considerably.
What to Watch This Week
February 21– 27
Notable economic events (February 21-25)
Tuesday: Flash PMIs, Conference Board Consumer Confidence, Richmond Fed, home prices (x2)
Wednesday: No major economic releases planned
Thursday: New home sales, KC fed, CFNAI, weekly jobless claims
Friday: Income and outlays, UofM consumer sentiment, pending home sales
It’s probably safe to say that Ukraine has now replaced COVID and all its various incarnations as the biggest external threat to market sentiment. While I generally believe that the impact of geopolitics on markets is often quite limited and confined almost entirely to a relatively short list of things that promise to alter the economic outlook in the longer term, the fact remains that big newsworthy events can set the tone in a very real way during the hours, days or weeks that they dominate the news cycle. I’d therefore expect Ukraine headlines to continue to push markets around this week.
Beyond that, the emphasis will be on data that either confirms or refutes the narrative we offered above: first, that inflation is still very much with us, even if small, hopeful signs of its maturity (and eventual easing) have begun to emerge; and second, that economic growth may have already peaked for this cycle.
Starting with inflation, Friday’s income and outlays report includes the Fed’s preferred measure of inflation – the so-called “personal consumption expenditure price index.” Given the huge numbers included in recent CPI- and PPI reports, it would take something truly shocking from the PCE to change the market’s view. That puts pressure on a few things related only on the periphery, like home prices, to do the dirty work. Tuesday will bring us two separate reads, including both the S&P/Case-Shiller 20-city composite and the FHFA’s home price index. Home prices have obviously remained elevated for a very long time and are likely contributing to inflationary sentiment in ways that aren’t perhaps immediately obvious, such as making equity-rich consumers somewhat more tolerant of rising prices (or perhaps even encouraging over-spending.) An easing of home price appreciation might therefore help take some of the steam out of inflationary pressures beyond its explicit impact on reported inflation figures by way of things like higher rental costs.
As far as the second bit – a plateauing of economic growth – we’ll get several different data points with which to measure that particular tendency. Beyond two more regional Fed manufacturing reports and Tuesday’s PMI data – which always provides a great forward-looking view into how businesses feel about the economic set-up, perhaps the most relevant comes on Friday with the closely-followed income and outlays report, which details how much Americans are earning and spending. Last week’s retail sales report for January already did some of the heavy lifting (spoiler alert: Americans returned to their spendy ways in January after a disappointing December report last month), meaning the “outlays” portion of this week’s report has a relatively high bar to clear in order to move the needle. That will likely shift the emphasis to the “income” portion, where economists will be on the lookout for any information suggesting incomes have stalled amid waning COVID-era support and still-disjointed labor markets.
And finally, we’ll get our final reads on consumer confidence for the month of February when the Conference Board releases its report on Tuesday, followed several days later by the University of Michigan’s consumer sentiment report on Friday. While the impacts of rising inflation and COVID on consumer attitudes have been well-documented in previous reports, it will be interesting to see the extent to which the worsening geopolitical environment has sapped consumer confidence.
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* Energy Information Administration, GWI calculations
Personal Capital Advisors Corporation (“PCAC”) is a wholly owned subsidiary of Personal Capital Corporation (“PCC”), an Empower company. PCC and Empower Holdings, LLC are wholly owned subsidiaries of Great-West Lifeco Inc. Source for index data: Bloomberg.com; GWI calculations.