Good Turns Bad? — Week of February 7, 2022

As of market close February 4, 2022. Returns in percent.

• Good turns bad? Great jobs report means Fed could raise rates more than expected
• Stocks healthier than November – better valuations, terrible sentiment, healing trend
• Jobs report much better than expected
• Halfway through earnings season – good results; need workers and supply chain improvement

Good Turns Bad?

We acknowledge statisticians have a hard life. Combining enough observations and populations into meaningful representations of reality takes a lot of brain power. Then the thanks they get are criticisms from fellow stat geeks and others. The headline jobs survey for January showed 467,000 net new jobs. This sounds great but there were several seasonal adjustments in the numbers. We will dig into the report more below. 

What about that market bottom we discussed last week? We now have two weeks of positive returns for the S&P 500, Dow Industrials and NASDAQ. Note that these are all large company indices. Our mid, small, and foreign friends are still finding their footing but mostly finished the week higher. Markets rarely instantly rebound from correction territory. The last two weeks are building a consolidation. Bottoms usually get tested before new highs are made. Two weeks ago, the fight was over Fed uncertainty. Last week’s action centered on company earnings and tech supplied the drama. That is, until Friday’s blowout jobs report that refocused attention on, yep, the Fed. 

Ramp

Data released last week showed January economic activity slowing and growing inflation. Dallas Fed Manufacturing Activity came in at 2, lower than the expected 8. ISM Manufacturing and Services pulled back from the previous month, but forward-looking surveys gave glimmers of optimism. The Prices Paid index jumped to 76.1 from 68.2 previously. Buildup of inventories in the Q4 GDP release showed that companies were able to increase their stocks of goods, amidst steady demand. The rebound from pandemic shutdowns took our economy to above trend growth. The next couple of years should have a ramp down to trend growth of 1.5% per year. How quickly we get there is up to the Fed. 
 
About that jobs report. Weekly jobless claims can give one a rough idea of hiring and layoff activity. Leading up to the mid-January jobs surveys, claims for unemployment insurance were rising, thanks to omicron spread. The week of the survey used for monthly payrolls was the week cases peaked. A “man on the street” (or cubicle) would think job creation fell during the most recent period. The private ADP report and most economists leaned toward low estimates. In fact, the ADP jobs report was negative.

The surprise of the week, especially given Fed and Administration’s couching toward weak data, was the 467,000 jobs added last month. The headline caught markets off guard, and they needed to dig into the details. On a very positive note, service jobs rose 440,000 for the month, showing gathering momentum for the beleaguered sector. Participation also gained significantly to 62.2%, up from 61.9%.

As the focus shifts back to the FOMC, does a big jobs number equal a 50bp rate hike in March? We believe the report increased odds slightly but are in the camp of Political Fed – a move and watch, nothing drastic. 

Across the Pond, things are heating up. Euro area unemployment is at record lows, while inflation is on the rise. The Bank of England increased short-term rates for the second meeting in a row. This is the first time since 2004 for the BoE. European Central Bank is on hold for now, but Lagarde matched Powell with a “hawkish” press conference. The impact has been significant. German Bunds are back in positive rate territory, Japan’s 10-year note is 4bp (above zero!) and global bonds with negative yields are now only $8 trillion, down from $17 trillion a year ago. This is having an impact on our dollar, down 2% this week.  

Shrinking

Pandemics accelerate trends that were already underway. Trucking is a prime example. Demographic trends meant that the driver pool was already aging. Drug tests and state drug legalization further cut the available population. Once shutdowns hit during Covid, trucking school output fell. Retirements were also accelerated by the shutdowns. 

Rising wages in other industries make punching a clock in a factory more competitive with the away-from-home lifestyle of long-haul trucking. Trucking firms are increasing wages in response. CFI Trucking President Greg Orr announced last week the firm raised driver pay, cut driver insurance premiums and added new bonuses. Wisconsin based Midwest Carriers is raising over-the-road pay by 9% one pay increase actually competitive with inflation.

New testing regulations created by the Federal Motor Carrier Safety Administration take effect today.  New drivers seeking a Class A license for trucking or school buses must graduate from one of the 2,363 training providers registered with the FMCSA. A client told us in their business there is one driver for every 13 loads. Does this shortage ease anytime soon? We are doubtful. There are several startups (Waymo, Nuro) and old-line manufacturers (Volvo) working on autonomous trucks – another trend acceleration – robots replacing humans.

Back Home

Texas, like the rest of the nation, has record job openings. We are encouraged by increasing job openings in oil and gas. Since bottoming at 244 active rigs in mid-August of 2020, the Baker Hughes rig count has nearly tripled to 613 last Friday. Inventories of crude and natural gas remain near five-year lows. 

Warmer temps thanks to La Nina muted price moves last fall. As winter set in, Ukraine worries and low supplies in Europe have helped push crude futures back up to 2014 levels. OPEC+ continues to be disciplined in moderating supply and U.S. producers are facing increasing regulatory hurdles. As omicron cases recede, demand should keep prices at least at these levels. 

280 Down

Halfway through earnings season the big picture is “on track.” 280 members of the S&P 500 have reported and are beating analysts’ estimates on cue. A large majority are either maintaining or raising guidance for the rest of the year. Last week’s excitement came from Meta (Meh or Facebook) and Amazon. 

Facebook changed their corporate name last year to “Meta Platforms,” supposedly short for the metaverse. Apparently the metaverse is an alternate digital world where we will all someday live. Meta reported a drop in daily users for the first time in its history and massive spending on the metaverse. Traders did not like the drop nor increasing expenditures and sent the stock 27% lower. That erased $250 billion in market cap from the stock. FB is one of the eight biggest stocks in the S&P 500 and put a dent in returns for the week in that index and the NASDAQ. The price movements do not change the fact that the company generated $117 billion in revenue with an 80% gross margin from 2 billion daily users last year. Ponder this: FB has a wider reach each day than any country can with its own population. That revenue stream may be a bargain, especially after Amazon cleaned up the week with an impressive report. 

Analysts projected Amazon would earn $3.57 per share last quarter but the company almost doubled that number, posting an impressive $5.80 per share. Full-year revenues rose 22% in 2021, nearly reaching $470 billion. The ecommerce giant said that earnings were held back by product shortages, supply chain and delivery and, of course, a lack of workers. Nearly every call we have reviewed this season puts the worker shortage ahead of supply chain worries. 

Away from the digital world, Eli Lilly did very well with Trulicity, a blood sugar drug. Honeywell and Cummins Engine were representative of most reports: demand strong and not going down anytime soon, but cannot get parts or enough raw materials. Big names on tap this week: DuPont, Coca-Cola, Pfizer, and Tyson Foods. 

Wrap-Up

Stocks continue to find a bottom. Valuations have markedly improved by prices dropping 8% to 15% and earnings continuing to rise. Sentiment remains very bearish – in a zone where a year later stocks are usually higher. Price action has stopped dropping for most stocks and started to consolidate. The market’s internals, such as the advance-decline, percent of stocks above moving averages, etc., are still in bearish territory but have stopped dropping.

The big jobs number raised the possibility of a half-point rate increase by the Fed in March. We still think those odds are low. Longer dated maturities, ten years and out, will likely not move much until the Fed stops reinvesting its bond portfolio. That should happen later in the year.

Steve Orr is the Executive Vice President and Chief Investment Officer for Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary’s University School of Law. Follow him on Twitter here. Mark Frears is an Investment Advisor at Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Science from The University of Washington, and an MBA from University of Texas - Dallas.

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