In this week’s narrative, we review recent events in Ukraine. We also discuss the fact that within the S&P 500 Index, the average stock is outperforming the Index. We review the recent sell off in the market, which reached the correction level last week. In our Chart of the Week, we evaluate what heightened economic policy uncertainty has historically meant for future equity returns. Finally, we discuss the recent outperformance of consumer services stocks relative to consumer goods companies.
Top Weekly Themes
- War In Europe – Russia has been in the news virtually nonstop of late. This was first due to Putin’s decision to amass troops on the border of Ukraine. Then, early last week Russia went further when they recognized the independence of two breakaway regions of Ukraine, sending troops into the territory in what they termed a “peacekeeping” mission. Early last Thursday this expanded into outright war when Russian troops and tanks moved into Ukraine and airstrikes hit over a dozen cities. Putin indicated that he ordered the military action to “demilitarize and denazify Ukraine.” The condemnation of these actions has been swift, with Germany halting moves to open the Nord Stream 2 gas pipeline – a $10 billion-plus pipeline that connects Russia’s natural gas to Germany. Many other countries, including the United States, announced sanctions against Russia. Equity markets around the world sold off hard on this news, with oil spiking to over $100 per barrel. The aforementioned events, when coupled with current inflationary pressures and Central Banks moving to raise interest rates, have created a high degree of economic uncertainty across the globe. While this is obviously very unnerving, in our Chart of the Week section (below) we discuss what heightened economic uncertainty has historically meant for equity returns going forward.
- Sometimes Average Is Good – Through the end of calendar 2021, the S&P 500 Index had posted an enviable five-year track record. Over that time, the widely followed Index produced returns that were substantially better than mid-sized (S&P Mid Cap 400) and small cap (S&P Small Cap 600) domestic equities. The S&P 500 also handily outperformed another version of itself, the equally weighted S&P 500. This is the same 500 stocks, just weighted in equal amounts, unlike the traditional Index which is market cap weighted. The outperformance over the past five years was fueled in large part by certain huge companies (mostly tech) generating outsized returns. However, as we chronicled several weeks ago, FAANG stocks are no longer moving in unison to the upside, with some of these names struggling mightily of late. This dynamic has the average stock outperforming the S&P 500 since the start of the year, with the equally weighted S&P 500 down -7.22% through last Thursday’s close, vs. -9.83% for the traditional S&P 500. We believe this trend is likely to continue for at least the next few months, which should be a tail wind for more diversified investors, like ourselves, which have lesser weights to the behemoths within the S&P 500.
- S&P Correction – When the S&P 500 finished trading last Tuesday, it had declined by 10.1% from its all-time closing high on January 3 – thus moving into correction territory. While events in Ukraine have been shouldering the blame for the pullback in equity markets, we continue to believe that investor focus will eventually shift back to the U.S. economy, more specifically inflation and the Federal Reserve (Fed). We are of the mind that inflation is peaking and that many 2021 forecasts for Fed action will be pared back as to their magnitude. This is critical to the continuation of the current economic expansion. If the Fed is forced to fight more persistent inflation, the economic recovery would be at greater risk.
|Russell 1000 Value||(4.0)||(5.8)||10.3||11.19||8.90||1.93|
|Russell 1000 Growth||(7.5)||(16.8)||4.8||21.05||19.05||0.74|
|MSCI EM (Emerging Markets)||(3.0)||(1.9)||(11.6)||7.21||7.66||2.47*|
|Fixed Income||Week||YTD||1-Year||3-Year||5-Year||Div Yield|
|Bloomberg Barclays US Aggregate||(0.1)||(4.2)||(3.6)||2.90||2.55||2.47|
|Bloomberg Barclays US High Yield – Corporate||(0.1)||(4.3)||(0.4)||5.27||4.81||5.75|
|Bloomberg Barclays Municipal Bond||0.3||(3.3)||(1.4)||3.15||3.27||1.90|
|Bloomberg Barclays Global Aggregate x US (Country)||(0.0)||(2.9)||(7.3)||1.50||2.29||1.47|
|Crude Oil WTI (NYM $/bbl) Continuous||(1.7)||22.5||49.3||17.2||11.1||92.1|
|Natural Gas (NYM $/mmbtu) Continuous||(2.0)||30.0||60.6||19.1||11.0||4.6|
|Gold NYMEX Near Term ($/ozt)||2.1||4.5||5.8||12.8||8.8||1,909.2|
|Copper Cash Official LME ($/mt)||(0.4)||3.2||9.2||15.5||10.8||10,005.0|
|Currencies||1 Week Ago||YTD||1-Year Ago||3-Years Ago||5-Years Ago||Current Level|
|U.S. Dollar per Euro||1.14||1.14||1.22||1.13||1.06||1.13|
|Japanese Yen per U.S. Dollar||115.43||115.16||105.12||110.76||112.60||115.04|
|U.S. Dollar per British Pounds||1.36||1.35||1.41||1.31||1.25||1.36|
Chart of the Week
Global Economic Policy Uncertainty has translated to Increased Forward Returns
The Global Economic Policy Uncertainty (GEPU) Index is a GDP-weighted average of the national GEPU indices for 21 countries. Included in that roster are the United States, Russia, and China, as well as numerous other sizable nations around the globe.
The Index itself mines the relative frequency of own-country newspaper articles that contain references to the economy, policy, and uncertainty. Over the past 20 plus years, this Index has only moved above 200 in eight instances, including the current move (at the end of January this Index was at 232).
With interest rates almost certain to be increased by the Fed next month, and other countries doing likewise, the added level of uncertainty is understandable. Then too, heightened inflation readings and the events unfolding in Ukraine only add to the ambiguity.
Relative to just a couple of months ago, the list of things creating angst around the globe has expanded, seemingly by the day. While this understandably creates investor unease, at least from a historical perspective, it also signals the likelihood of outsized equity returns over the next year.
Intuitively this makes sense, as investors sell stocks, depressing valuations, during periods of greater economic uncertainty. Once the heightened uncertainty passes, stocks recover, leading to outsized returns earned on investments made during times of excessive economic uncertainty.
Goods > Services
Many consumer services stocks (particularly travel-related) suffered during the pandemic, while goods companies reaped the benefit of consumers that used savings and stimulus checks to shop online for new furniture and other hard goods.
As the bottom panel of the chart above displays, the relative performance of these two groups of stocks started to shift in favor of services stocks last September and has continued to turn decidedly in that direction. The market is signaling a strong and full reopening, and one of the notable beneficiaries of this has been hotel stocks, which have seen substantial advances over recent months.
On the other side of the ledger are consumer goods companies, many of which saw huge increases in sales (and often margins), as a result of overwhelming pandemic induced demand. Case in point, furniture retailer Williams-Sonoma (WSM), the parent company of Pottery Barn.
WSM experienced top-line growth of over 20% for four consecutive quarters during the pandemic, a figure which dwarfs its long-term average in the mid-single digits. Then too, profit margins also moved higher as discounting and sales were greatly curtailed. We owned this stock in our Multi-Cap SMA Strategy since the outset of the pandemic, but liquidated the name earlier this month – concluding that for the foreseeable future, WSM faces a far more challenging environment than what it enjoyed in the immediate past.