Presented by Mark Gallagher

With the recent market pullback, investor concerns are starting to mount. To be sure, there is plenty to worry about—the Omicron wave, inflation, interest rates, and a potential war in Ukraine, just to name a few. Given all the things that could go wrong, is a stock market crash an inevitable outcome?

To help answer that question, we first need to consider where stock prices come from. From there, we can determine what would have to happen for some of the worst-case scenarios to become reality. And once we have that figured out? We can decide how realistic we think those events are (or not).

Unpacking Stock Prices
So, where exactly do stock prices come from? Here, there are two things that matter: earnings and how much investors will pay for those earnings (i.e., valuations).

Earnings. Earnings, of course, come from companies, which come from people working and spending. Right now, the job market is very healthy from an employee’s standpoint, with a shortage of workers and consequent pay increases, and that has helped keep consumer spending growing. From an employer’s perspective, of course, that is a cost. But that too has a good side, as businesses are selling a lot to those spenders and are being forced to invest since they can’t hire.

Between consumer spending and business investment, earnings are expected to keep rising through 2022. Other things being equal, the market responds to changes in earnings. If earnings go up, the markets rise. Given the way the economy is growing, it likely won’t be a drop in earnings that takes the market down this year.

Valuations. So, if a market drop will not be about earnings, then it has to be about valuations. Here, you can tell a pretty convincing story. As of this writing (January 24, 2022), stock prices for the S&P 500 companies are now at about 20 times the earnings expected in the next year. In 2007, just before the financial crisis, stocks were at about 15 times the next year’s expected earnings. If we revert to the 2007 valuation level, this would imply that another 25 percent drop in the market is possible from here. During the financial crisis itself, moreover, stocks dropped to a valuation level of about 10, which would imply another 50 percent decline from here. Using historical data, we can get to that 50 percent decline prediction.

But recent experience has been different. Valuations are tied to interest rates, and rates have been lower since the financial crisis—usually much lower. This has allowed stock valuations to drift higher. If we look at more recent data from Yardeni Research outside of the depths of crises (since, say 2013, when the post-financial crisis recovery really got going), we see something different. Here, the lowest valuation level is about 14 times, and most of the post-2016 data has been at 16 times or higher. Even the market collapse at the start of the pandemic bottomed out at about 14 times. In other words, with rates low, valuations have been sustainably much higher since the financial crisis.

If we take 14 as a bottom for valuations, that could imply another 30 percent downside from here. But that would require another serious systemic crisis, and the problems we have now don’t even begin to approach the ones we had then. If we take the more normal 16 times valuation as a bottom for normal worry levels, that could result in another 20 percent drop from here. As a reasonable worst case, absent another systemic crisis, this makes sense.

Is This Normal?
As of this writing (January 24, 2022), the S&P 500 is down a bit more than 10 percent from the all-time high. The Nasdaq is down a bit more, at almost 17 percent. These are meaningful drawbacks, and it makes sense to want to react. They are also, however, perfectly normal volatility, which we see in the markets pretty much every year. So far, at least, this is normal market behavior and a rational response to the very real risks we summarized at the start. With everything that is going on, it makes sense for markets to pull back a bit, and that is what we are seeing.

As the worst-case numbers above indicate, markets might well drop more, as the perceived risks rise. That too would be reasonable, and it is something we have seen in recent history. But absent some kind of systemic shock, as long as earnings stay solid and interest rates remain in the range we have seen in the five years before the pandemic, stock prices are likely to have a solid foundation over time. That solid foundation also suggests that when those worries subside, valuations and stock prices can bounce back reasonably quickly, as we saw in 2020, 2018, and indeed after the financial crisis itself.

The Stock Market Is Not Crashing
This analysis shows a market crash remains unlikely, which is good. But more important, it shows what would have to happen to get a crash. Some kind of systemic crisis would do it. So would a collapse of the economy, knocking earnings down. Finally, if interest rates were to spike up and stay there, we could well see valuations drop sharply. A crash could happen, but this is what would have to precede it.

And this is the context we should be considering when we look at those predictions of a crash. Are any of those happening? We will keep watching for them, but so far the answer is no. So, while the market can and almost certainly will show occasional sharp drops, as long as the economy continues to grow and interest rates stay at the levels we saw from 2015 to 2019, the foundations remain solid.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poor’s. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures.

Mark Gallagher is a financial advisor located at Gallagher Financial Services at 2586 East 7th Ave. Suite #304, North Saint Paul, MN 55109. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 651-774-8759 or at mark@markgallagher.com.
Authored by the Investment Research team at Commonwealth Financial Network.
© 2022 Commonwealth Financial Network®

Presented by Mark Gallagher

General Market News
• The yield curve saw modest flattening last week. The short end of the curve continued its move higher and the long end of the curve held steady. The U.S. 2-year Treasury yield increased another 9.7 basis points (bps), closing at 0.967 percent. The 10-year Treasury yield increased 0.6 bps while the 30-year Treasury yield actually fell 0.2 bps. This news may indicate that the move in yields is approaching a near-term ceiling as appetite from investors keeps bond yields in check at this level. We will see if this trend continues and expands to the short end of the curve in the future.
• Global equity markets showed mixed performance last week as investors questioned whether we saw peak inflation with Wednesday and Thursday’s Consumer Price Index (CPI) and Producer Price Index (PPI) reports. The Nasdaq Composite Index outperformed the Dow Jones Industrial Average despite the Russell 1000 Growth underperforming the Russell 1000 Value 1.03 percent. Elsewhere, the MSCI EAFE outperformed the S&P 500 and MSCI Emerging Markets Index outperformed all areas, posting a gain of 2.57 percent. Dollar weakness and a potential rate ceiling helped the region. Energy was a standout performer as West Texas Intermediate crude rose 6.2 percent. Communication services and technology also performed well as growth stocks rallied. The worst-performing sectors were REITs, consumer discretionary, and utilities.
• On Wednesday, the CPI report for December was released. Consumer prices rose 0.5 percent, down from the 0.8 percent increase we saw in November but slightly above economist estimates. On a year-over-year basis, consumer prices increased 7 percent in December, which was in line with expectations. This represents the highest level of year-over-year consumer inflation since 1982. Core consumer prices, which strip out volatile food and energy prices, rose 0.6 percent in December and 5.5 percent on a year-over-year basis. This was slightly higher than economist estimates for a 0.5 percent monthly and 5.4 percent year-over-year increase. Consumer prices experienced upward pressure throughout 2021, fueled by high levels of pent-up consumer demand, thin business inventories, and tangled global supply chains. Looking forward, the Federal Reserve (Fed) is expected to focus on combating inflation in 2022 as the central bank works to normalize monetary policy.
• Thursday saw the release of the PPI report for December. Producer prices increased 0.2 percent, down notably from the revised 1 percent increase we saw in November and below estimates for a 0.4 percent increase. On a year-over-year basis, producer prices increased 9.7 percent in December, which was slightly below estimates for a 9.8 percent rise. Core producer prices, which strip out the impact of volatile food and energy prices, increased 0.5 percent in December and 8.3 percent on a year-over-year basis. Similar to consumer prices, producer prices have been pressured this year due to supply chain constraints. Producers have also had to contend with rising material and labor costs, which contributed to the increase in inflationary pressure throughout the year.
• On Friday, the December retail sales report was released. Retail sales were disappointing, as headline sales dropped 1.9 percent against calls for a more modest 0.1 percent decline. This marks the first month with declining sales since July, and it’s a sign that rising medical risks and inflationary pressure weighed on consumer spending to finish the year. The declines were widespread, as 10 of the 13 categories in the report showed a drop in sales, led by an 8.7 percent drop in nonstore sales. Core retail sales, which strip out the impact of auto and gas sales, fell 2.5 percent against calls for a 0.2 percent decline. Despite the miss against expectations in December, earlier strength in consumer spending growth throughout the quarter and year helped blunt some of the disappointment from this report. This will be a widely monitored release in the coming months, given the importance of consumer spending on the pace of the overall economic recovery.
• We finished the week with Friday’s release of the preliminary estimate of the University of Michigan consumer sentiment survey for January. Consumer sentiment fell more than expected to start the new year, dropping from 70.6 in December to 68.8 to start January against calls for a drop to 70. This result, which brought the index close to its recent low of 67.4, signals continued consumer unease. The larger-than-expected drop was largely due to a decline in the future expectations subindex. Future expectations declined, in part, due to rising inflation expectations, as 1-year and 5-year consumer inflation expectations increased, despite messaging from the Fed that the central bank is committed to combating inflation in the new year. The current conditions subindex also declined, which was likely due to the rise in case growth we’ve seen because of the Omicron variant.

Source: Bloomberg, as of January 14, 2022

Source: Morningstar Direct, as of January 14, 2022

What to Look Forward To
On Tuesday, the National Association of Home Builders Housing Market Index for January was released. Home builder confidence dropped modestly to start the year, as the index fell from 84 in December to 83 in January against calls for no change. This is a diffusion index, where values above 50 indicate expansion, so this result signals continued construction growth despite the decline. Home builder confidence has remained in solid expansionary territory following the expiration of initial lockdowns in 2020. Since then, high levels of home buyer demand and a lack of homes for sale have supported faster construction growth. Home builder confidence sits well above pre-pandemic levels, signaling more construction growth in the months ahead. The continued strength of home builder confidence is impressive, given the headwinds caused by rising material and labor costs for home builders. Today’s report indicates a healthy housing sector to start the new year.

Speaking of new home construction, Wednesday will see the release of the December building permit and housing starts reports. These measures of new home construction are expected to show a modest decline, following larger-than-anticipated increases in November. Permits are set to drop 0.7 percent in December, after rising 3.6 percent in November. Starts are set to go down 1.7 percent, following an 11.8 percent surge in November. These reports can be quite volatile on a month-to-month basis. Throughout the pandemic, however, the pace of new home construction has remained above pre-pandemic levels. Record-low mortgage rates and a desire for more space due to the pandemic have supported a surge in home buyer demand. Because existing homeowners were hesitant to put their homes up for sale, newly built homes sold quickly throughout 2021.

We’ll finish the week with Thursday’s release of the December existing homes sales report. Existing home sales are set to decline 0.8 percent, following a better-than-expected 1.9 percent increase in November. Still, the pace of sales is expected to remain well above pre-pandemic levels despite the anticipated drop. In fact, if estimates prove accurate, existing home sales would be up 12.6 percent on an annual basis, compared with the pre-pandemic high recorded in February 2020. Looking forward, the low supply of homes for sale as well as rising prices and mortgage rates may serve as a headwind for significantly faster growth of existing home sales. If we continue to see sales near current levels, however, they would signal a healthy housing sector.

Disclosures: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poor’s. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The Dow Jones Industrial Average is computed by summing the prices of the stocks of 30 large companies and then dividing that total by an adjusted value, one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index. The Bloomberg US Aggregate Bond Index is an unmanaged market value-weighted performance benchmark for investment-grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities with maturities of at least one year. The U.S. Treasury Index is based on the auctions of U.S. Treasury bills, or on the U.S. Treasury’s daily yield curve. The Bloomberg US Mortgage Backed Securities (MBS) Index is an unmanaged market value-weighted index of 15- and 30-year fixed-rate securities backed by mortgage pools of the Government National Mortgage Association (GNMA), Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (FHLMC), and balloon mortgages with fixed-rate coupons. The Bloomberg US Municipal Index includes investment-grade, tax-exempt, and fixed-rate bonds with long-term maturities (greater than 2 years) selected from issues larger than $50 million. One basis point is equal to 1/100th of 1 percent, or 0.01 percent.

Mark Gallagher is a financial advisor located at Gallagher Financial Services at 2586 East 7th Ave. Suite #304, North Saint Paul, MN 55109. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 651-774-8759 or at mark@markgallagher.com.
Authored by the Investment Research team at Commonwealth Financial Network.

© 2020 Commonwealth Financial Network®

Presented by Mark Gallagher

General Market News
• The yield curve moved higher across the board last week, and a noticeable shift across all maturities also occurred. The U.S. 2-year Treasury yield opened the week at 0.743 percent and closed 12.7 basis points (bps) higher at 0.870 percent. The U.S. 10-year Treasury yield increased 25.7 bps to 1.769 percent. Finally, the U.S. 30-year Treasury yield moved 21.2 bps higher, closing at 2.117 percent. Higher rates spooked equity market investors as the Federal Reserve’s (Fed’s) meeting minutes indicated it would be more aggressive with raising rates and tapering asset purchases.
• Global equity markets were down across the board last week as Treasury yield curve rates shifted higher. This resulted in high-flying technology and consumer discretionary names—including Microsoft (MSFT), NVIDIA (NVDA), Alphabet (GOOG/GOOGL), Amazon (AMZN), Netflix (NFLX), Adobe (ADBE), and SalesForce (CRM)—being sold off. Real estate, technology, health care, communication services, and consumer discretionary were among the hardest-hit sectors. Outperforming sectors included energy, financials, industrials, consumer staples, and materials. The market is punishing names that have benefited from the Fed’s actions during the pandemic, including the purchase of mortgage-backed securities, which have reduced mortgage and other interest rates and powered growth in technology and health care. The equity market appears to be playing with higher rates and inflation, which shows uncertainty over whether the Fed or inflation will win out in the short term and in 2022.
• On Tuesday, the Institute for Supply Management (ISM) Manufacturing survey for December was released. This widely monitored gauge of manufacturer confidence declined by more than expected during the month, as the index fell from 61.1 in November to 58.7 in December against calls for a more modest drop to 60. This is a diffusion index where values above 50 indicate expansion, so this result still signals growth for the manufacturing industry. Manufacturer confidence was supported in 2021 as lessened restrictions on business activity and the overall economic recovery allowed for increased factory production throughout the year. High levels of business confidence have historically supported faster levels of business spending growth, so December’s result is a good sign for business spending as we kick off the new year.
• Wednesday saw the release of the December Federal Open Market Committee meeting minutes. These minutes were highly anticipated due to the central bank’s announcement that it would be cutting the level of its monthly asset purchases by more than initially expected in the months ahead. This announcement signaled that the Fed is committed to normalizing monetary policy sooner than originally anticipated. Economists and investors were looking forward to the release of the minutes in order to gain insight into what factors caused the Fed to increase the pace of the asset purchase tapering. The minutes showed that Fed members were concerned about the high inflation rates throughout 2021, and the attempt to normalize monetary policy more quickly was due, in part, to fears about continued inflationary pressure in 2022. The minutes also contained preliminary discussion about the Fed’s balance sheet and potential steps to lower the Fed’s Treasury bond holdings in the years ahead. While it’s too early for any firm commitment for balance sheet reduction from the central bank, the preliminary discussions indicated that some Fed members viewed the end of 2022 as a potential start date for balance sheet reductions, which would be another step toward normalizing monetary policy.
• On Thursday, the November international trade balance report was released. The report showed that the trade deficit increased by less than expected, with the gap rising from a revised $67.2 billion in October to $80.2 billion in November against calls for further expansion to $81 billion. This brought the monthly trade deficit to its second-largest level on record, trailing only September’s $81.4 billion deficit. The increase in the deficit was driven by a surge in imports during the month, as retailers tried to stock up for the important holiday season. Imports increased 4.6 percent, which was more than enough to offset the 0.2 percent increase in exports. Trade was a net drag on economic growth in the third quarter, and the deficit in November indicates that the headwind may continue into the fourth quarter. Looking forward, global economic recovery is expected to help lead to a more normal trading environment.
• Thursday also saw the release of the ISM Services index for December. Service sector confidence dropped by more than expected, as the index fell from 69.1 in November down to 62 in December against calls for a more modest decline to 67. This larger-than-expected decline left the index in healthy expansionary territory, as this is another diffusion index where values above 50 indicate growth. That said, service sector business owners noted a slowdown in new orders, which was likely due to the uncertainty caused by the Omicron variant. Despite the decline in confidence during the month, the employment component of the report showed that service sector businesses continued to hire in December, which was an encouraging sign for future service sector growth.
• We finished the week with Friday’s release of the December employment report. The report showed that 199,000 jobs were added during the month, which was down from the upwardly revised 249,000 jobs that were added in November and below economist estimates for 450,000 jobs. While the miss against expectations was disappointing, the monthly job figures have been subject to high levels of revisions over the past few months, as the October and November job reports were revised up by a combined 141,000 jobs. Additionally, the underlying data showed further signs of improvement, as the unemployment rate fell from 4.2 percent to 3.9 percent against calls for a more modest drop to 4.1 percent. This marks an impressive improvement, as the unemployment rate fell from 6.7 percent in December 2020 to 3.9 percent in December 2021. Given the relatively low unemployment rate and continued wage growth, the report is expected to support the Fed’s decision to increase the pace of its asset purchase tapering in the months ahead.

  Source: Bloomberg, as of January 7, 2022

  Source: Morningstar Direct, as of January 7, 2022

What to Look Forward To
Wednesday will see the release of the Consumer Price Index for December. Consumer prices are expected to increase 0.4 percent during the month, down from a 0.8 percent jump in November. On a year-over-year basis, the estimates are for 7.1 percent growth, up from a 6.8 percent rise in November. Core consumer prices, which strip out volatile food and energy prices, are expected to go up 0.5 percent during the month and 5.4 percent year-over-year. Tangled supply chains, lean business inventories, and high levels of pent-up consumer demand led to higher-than-anticipated consumer inflation throughout much of 2021. These inflationary pressures are expected to remain in play toward the end of the year. Given the recent actions and commentary from the Fed, many economists believe the central bank will move more swiftly to combat inflation in 2022. We may see a more hawkish Fed than currently expected.

On Thursday, the Producer Price Index for December is set to be released. Producer prices are also expected to increase 0.4 percent, following a 0.8 percent rise in November. As for headline year-over-year producer inflation, the calls are for a rise of 9.8 percent in December, slightly higher than November’s 9.6 percent year-over-year gain. Core producer prices, which strip out food and energy prices, are expected to go up 0.4 percent during the month and 8 percent year-over-year. As was the case with consumer prices, producer prices were pressured throughout 2021 due to supply chain constraints. Additionally, rising material and labor costs contributed to rising inflationary pressure felt by producers throughout 2021. If estimates prove accurate, this report would support the Fed’s anticipated plans for more aggressive policy in 2022.
Friday will see the release of the December retail sales report. Retail sales are expected to decline 0.1 percent during the month, following a 0.3 percent increase in November. If estimates hold, this report would mark the first drop for sales since July 2021. It would be a sign that rising medical risks in December weighed on consumer spending. Throughout most of last year, consumer spending growth was positive, supported by improvements on the public health front that allowed the easing of state and local restrictions. Although widespread shutdowns are not anticipated at this time, it’s possible the recent rise in case growth will negatively affect consumer spending in the short term. Given the importance of consumer spending to economic growth, this release will be widely monitored. Economists will use it to gauge the impact of recent case growth on spending and the overall economic recovery.

Friday will also see the release of the December industrial production report. Industrial production is expected to increase 0.3 percent during the month, following a 0.5 percent gain in November. If estimates hold, this report would mark three consecutive months with improved production. November’s solid result was supported by an increase in factory production and manufacturing output. Manufacturing production rose 0.7 percent in November, and economists expect that result to be followed by a 0.4 percent uptick in December. Capacity utilization in November reached the highest level since December 2018, and further improvements are expected in December’s report. Throughout the pandemic, producers have been slower to recover compared with consumers. Still, we’ve seen steady progress in getting production back to pre-pandemic levels. Overall, if estimates prove accurate, this report would mark a solid result. It would show that production continued to recover to end the year, supported by high levels of consumer and business demand.

We’ll finish the week with Friday’s release of the preliminary estimate of the University of Michigan consumer sentiment survey for January. Consumer sentiment is expected to decline slightly from 70.6 in December to 70 to start the new year. If estimates hold, this report would bring the index close to the recent low of 67.4 recorded in November 2021. Consumer sentiment dropped toward the end of last summer and remained well below pre-pandemic levels throughout the year. Consumers cited rising inflationary pressure as the major driver of the collapse in sentiment. The survey has, however, taken on a notable partisan split. Republican respondents expect significantly higher levels of inflation in the short and intermediate term compared with democrats. These disparate inflation expectations have caused overall confidence levels to diverge. Republican consumers had an overall sentiment level of 45.6 in December 2021, while democrats registered 90.8, marking one of the largest gaps on record. Looking forward, further progress in getting inflation under control will likely be needed before we see a notable improvement in overall consumer sentiment.

Disclosures: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poor’s. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The Dow Jones Industrial Average is computed by summing the prices of the stocks of 30 large companies and then dividing that total by an adjusted value, one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index. The Bloomberg US Aggregate Bond Index is an unmanaged market value-weighted performance benchmark for investment-grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities with maturities of at least one year. The U.S. Treasury Index is based on the auctions of U.S. Treasury bills, or on the U.S. Treasury’s daily yield curve. The Bloomberg US Mortgage Backed Securities (MBS) Index is an unmanaged market value-weighted index of 15- and 30-year fixed-rate securities backed by mortgage pools of the Government National Mortgage Association (GNMA), Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (FHLMC), and balloon mortgages with fixed-rate coupons. The Bloomberg US Municipal Index includes investment-grade, tax-exempt, and fixed-rate bonds with long-term maturities (greater than 2 years) selected from issues larger than $50 million. Basis points (bps) is a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1 percent, or 0.01 percent.

Mark Gallagher is a financial advisor located at Gallagher Financial Services at 2586 East 7th Ave. Suite #304, North Saint Paul, MN 55109. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 651-774-8759 or at mark@markgallagher.com.
Authored by the Investment Research team at Commonwealth Financial Network.
© 2020 Commonwealth Financial Network®

Presented by Mark Gallagher

General Market News
• The yield curve moved modestly higher last week with a majority of the move taking place on the short end of the curve. The 2-year U.S. Treasury yield opened the week at 0.693 percent and closed the week 4.1 basis points (bps) higher at 0.734 percent. The U.S. 10-year Treasury increased 1.9 bps to 1.513 percent. Finally, the 30-year Treasury was flat, opening and closing at 1.905 percent. The front end of the curve rose as more persistent inflation forced it to reduce its asset purchases at a faster clip, and rates could potentially follow if we continue to see lingering, elevated inflation.
• The U.S. equity markets were mixed last week as trends from 2021 started to reverse following the December Federal Open Market Committee (FOMC) meeting. The meeting, which stated the Federal Reserve (Fed) would speed up the rate at which it reduces its asset purchases, led investors to question whether rate hikes would shortly follow the taper, which is expected to end in March. As a result, the Dow Jones Industrial Average and International MSCI EAFE Index began to outperform as communication services, energy, and consumer discretionary struggled. Health care, consumer staples, industrials, and financials started to gain some appetite from investors as high-flying tech and communication services have underperformed after a strong 2020 and 2021.
• There were no major economic data releases last week.

  Source: Bloomberg

  Source: Morningstar Direct

What to Look Forward To
On Tuesday, the ISM Manufacturing index for December is set to be released. This widely monitored gauge of manufacturer confidence is expected to decline modestly from 61.1 in November to 60.2 in December. This is a diffusion index, where values above 50 indicate expansion. So, if the estimates hold, this report would signal continued growth for the manufacturing industry despite the anticipated decline. Throughout 2021, manufacturer confidence was supported by the easing of state and local restrictions, which allowed for more factory production. Historically, high manufacturing confidence has supported business investment and faster production growth, so the anticipated strong reading for December would be an encouraging signal. It would demonstrate that manufacturing output has continued to grow, despite the headwinds created by tangled global supply chains and the worsening public health situation.

On Wednesday, the December FOMC meeting minutes are set to be released. The minutes are expected to give economists and investors a closer look into the deliberations from the FOMC’s December meeting. At that meeting, the Fed announced it would reduce its secondary market asset purchases by more than expected in the months ahead. This was a signal that the Fed is moving to normalize monetary policy sooner than originally anticipated. While this announcement was widely expected, the minutes should give additional information on the factors contributing to the Fed’s change of heart. Looking forward, the Fed is expected to support maximum employment and stable prices. The Fed will also ease off the supportive policies put in place to combat the economic impact of the pandemic. We’ve seen notable progress for the labor market recovery since the expiration of initial lockdowns. As we kick off the new year, high levels of inflationary pressure will likely be the Fed’s primary concern.

On Thursday, the November international trade balance report is set to be released. The trade deficit is expected to increase from $67.1 billion in October to $74.1 billion in November. If estimates hold, this result would offset some of the recent decline in the monthly deficit. Still, the monthly deficit would remain well below the record $81.4 billion recorded in September. Throughout the pandemic, this deficit has increased notably, as the uneven global recovery and high consumer demand in the U.S. caused a surge in imports without a similar increase in exports. The previously released advanced estimate of the trade of goods showed that exports fell 2.1 percent in November, while imports increased 4.7 percent. Looking ahead, the continued global economic recovery is expected to lead to further normalization of trade. Still, we’ll likely need continued progress on the medical front before seeing a full return to normal trade levels.

Thursday will also see the release of the ISM Services index for December. This index, which monitors service sector confidence, is expected to decline modestly from a record high of 69.1 in November to 67.1 in December. As was the case with the manufacturing index, this is a diffusion index where values above 50 indicate growth, so the anticipated result would be a good sign. Service sector confidence spent much of 2021 at or near record highs. Contributing factors were the pent-up consumer demand and successful reopening efforts that led to a surge in service spending. The service sector accounts for the vast majority of economic activity in the country. Throughout 2021, strong levels of confidence and spending in this sector helped drive the overall economic recovery.

We’ll finish the week with Friday’s release of the December employment report. Economists expect to see 400,000 jobs added during the month, a solid increase from the 210,000 jobs added in November. Earlier in the year, hiring increased notably, due to the improving medical statistics and easing restrictions, as well as pent-up consumer demand. By year-end, however, the pace of improvements slowed a bit. With that said, if estimates hold, this report would mark 12 consecutive months with job growth, signaling further recovery for the labor market. The underlying data is also expected to show some improvements. The unemployment rate is set to fall from 4.2 percent in November to 4.1 percent in December. This would mark a decline from the December 2020 unemployment rate of 6.7 percent, highlighting the progress made in getting folks back to work in 2021.

Disclosures: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poor’s. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The Dow Jones Industrial Average is computed by summing the prices of the stocks of 30 large companies and then dividing that total by an adjusted value, one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index. The Bloomberg US Aggregate Bond Index is an unmanaged market value-weighted performance benchmark for investment-grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities with maturities of at least one year. The U.S. Treasury Index is based on the auctions of U.S. Treasury bills, or on the U.S. Treasury’s daily yield curve. The Bloomberg US Mortgage Backed Securities (MBS) Index is an unmanaged market value-weighted index of 15- and 30-year fixed-rate securities backed by mortgage pools of the Government National Mortgage Association (GNMA), Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (FHLMC), and balloon mortgages with fixed-rate coupons. The Bloomberg US Municipal Index includes investment-grade, tax-exempt, and fixed-rate bonds with long-term maturities (greater than 2 years) selected from issues larger than $50 million. Basis points (bps) is a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1 percent, or 0.01 percent.

Mark Gallagher is a financial advisor located at Gallagher Financial Services at 2586 East 7th Ave. Suite #304, North Saint Paul, MN 55109. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 651-774-8759 or at mark@markgallagher.com.
Authored by the Investment Research team at Commonwealth Financial Network.
© 2020 Commonwealth Financial Network®