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01.26.22

January 2022 Economic Commentary

By Jesse Ellington, III

More Volatility Coming
 
As expected, 2022 is starting off with significant volatility and uncertainty. While we are cautious in the short term because of rising rates and a persistent virus, our intermediate outlook still remains positive based on significant pent up consumer demand, ample liquidity, and solid corporate earnings. Q1 should be the rockiest, as we digest both the consumption impact of the “omicron wave” on earnings, as well as the degree to which the Fed reacts to inflation.

In addition, there is an amplified possibility of two headline events that could add to market volatility. The first would be a military move by Russia to take over Ukraine; in 2014 when Russia invaded Crimea, the markets reacted to the downside but recovered quickly. The other would be a surprise rate move by the Fed outside normal expectations, let’s say 50-75 basis points. This would also take the market down in the short term, though calmer heads should eventually prevail under the assumption that the Fed is finally getting ahead of inflation. The probability of these two risks is still at the low end, given that each would entail aggressive decision making with uncertain consequences. Overall we would view either of these scenarios as a buying opportunity.          

Other issues front and center revolve around valuation and speculation. On the positive side, much of the speculation we have mentioned in previous updates has been unwinding rapidly. From SPACs to money-losing small caps and unprofitable growth IPOs, the balloon has been deflating rapidly over the last two months. This deflation also extends to most of the hyped-up COVID shutdown plays from a year ago as shown in the chart below:

January 2022 Commentary Chart

The purging of this excess is a positive sign as long as it doesn’t bleed over to the S&P 500, which still sits at a very lofty valuation of 20x forward earnings. This level is more difficult to justify if rates continue rising and growth is truly leveling off. Against this backdrop, we are keeping a keen eye on 2022 earnings guidance and valuations. This could be a breakout year for adherents of a “GARP” (Growth at a Reasonable Price) approach, which is a core component of how we view the equity market.  

From a sector perspective, almost every market strategist out there is pushing overweights in both financials and energy. This is backed up by money flow, as both those sectors are up this year while the S&P is down 5% and the NASDAQ close to 8%. We think a market weight is warranted given the muted long term outlook of both sectors, which makes it difficult to justify anything more in our view.

Within fixed income, a rising rate environment favors credit, within limits, as well as lower duration. This fixed income barbell should produce positive returns this year in an environment where the aggregate bond index could be down significantly. On the flipside, it’s getting harder to find ways to protect client portfolios given low returns in investment grade and government bonds. Overall, the bear market in bonds may be short lived if hawkish Fed policies slow the economy down too much. We believe the Fed is balancing on a razor’s edge at the moment, with the economy too fragile to handle excessive rate increases. Before we know it, we could be moving back toward zero rates like Japan and Europe as the Fed’s tightening cycle proves short lived. In the meantime, it will be a stock pickers market as volatility creates some attractive entry points for high cash flow, growth oriented companies.

Please call or email me with any questions or observations at jess.ellington@aubwm.com or 843-412-1420.

Disclosures:
Atlantic Union Bank Wealth Management is a division of Atlantic Union Bank that offers asset management, private banking, and trust and estate services. Securities are not insured by the FDIC or any other government agency, are not deposits or obligations of Atlantic Union Bank, are not guaranteed by Atlantic Union Bank or any of its affiliates, and are subject to risks, including the possible loss of principal. Deposit products are provided by Atlantic Union Bank, Member FDIC.

Past performance quoted is past performance and is not a guarantee of future results. Portfolio diversification does not guarantee investment returns and does not eliminate the risk of loss. The opinions and estimates put forth constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.


About the Author
Jesse Ellington, III
Jesse started out his career as an analyst perfecting the craft of digging into companies, moved to the investment management consulting business where understanding proper asset allocation was key, and spent 12 years running a hedge fund and honing his macro skills. He brings all that experience to Atlantic Union Bank Wealth Management in his role of Chief Investment Officer. 

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