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Bears Remain in Control in Dismal Start to 2022

U.S. equities finished a shortened week lower, notching a third-consecutive week of losses, in what has been a volatile start to 2022. As has been the theme over the past sessions, early gains faded and succumbed to concerns over the economic implications of a potentially more aggressive Fed amid persistent inflation pressures, and the expectations of rising interest rates. The rebound in the Information Technology sector fell flat, leading in this week's sharp drop that pulled the Nasdaq into correction territory. Meanwhile, Energy stocks trimmed a recent rally as crude oil prices pared a recent run, and Financials also weighed on the broad markets with Treasuries sharply higher to apply noticeable pressure on yields. Adding to the Nasdaq's woes, Netflix plunged after its stronger-than-expected Q4 results were overshadowed by Q1 guidance that suggested subscriber growth and revenue would be decisively below the Street's forecast. In other equity news, CSX Corporation slightly beat quarterly estimates, but labor and fuel costs weighed on profitability, and Dow member Intel Corporation announced an initial $20 billion investment to build chip factories in Ohio. One of the few bright spots of the day was the tenth-straight monthly gain for the Leading Economic Index for the month of December. The U.S. dollar dipped, and gold prices traded to the downside. Markets in both Europe and Asia finished broadly lower as markets overseas also saw increased volatility.

The Dow Jones Industrial Average fell 450 points (1.3%) to 34,265, the S&P 500 Index declined 85 points (1.9%) to 4,398, and the Nasdaq Composite was 385 points (2.7%) lower at 13,769. In heavy volume, 5.5 billion shares of NYSE-listed stocks were traded, and 5.8 billion shares changed hands on the Nasdaq. WTI crude oil lost $0.41 to $85.14 per barrel. Elsewhere, the gold spot price traded $12.60 lower to $1,830.00 per ounce, and the Dollar Index—a comparison of the U.S. dollar to six major world currencies—shed 0.1% to 95.16. Markets were noticeably lower for the week, marking a third-straight week of losses, as the DJIA was down 4.6%, the S&P 500 tumbled 5.7%, and the Nasdaq Composite plunged 7.6%.

Netflix Inc. (NFLX $398) reported Q4 earnings-per-share (EPS) of $1.33, above the $0.83 FactSet estimate, as revenues grew 16.0% year-over-year (y/y) to $7.7 billion, roughly in line with the Street's forecast. Q4 global net streaming paid subscriber additions came in at 8.3 million, above estimates of 8.2 million. However, the company's shares are tumbling after it forecasted Q1 global net streaming paid subscriber additions of 2.5 million, decisively below the 6.9 million increase that analysts had anticipated, while its EPS and revenue guidance also came in well south of forecasts.

NFLX said competition has only intensified over the last 24 months as entertainment companies all around the world develop their own streaming offering. The company noted that while this added competition may be affecting its marginal growth some, it continues to grow in every country and region in which these new streaming alternatives have launched, adding that it has tremendous room for growth if it can continue to improve its service. Shares tumbled over 20%.

CSX Corporation (CSX $34) posted Q4 EPS of $0.42, one penny above expectations, with revenues rising 21.0% y/y to $3.4 billion, topping the projected $3.3 billion. The rail company said its key measure of profitability, the operating ratio—operating expenses as a percentage of revenue—increased to 60.1% from 57.0% in the prior year period amid higher labor and fuel costs. However, CSX did note that it saw growth across all major lines of business, and it enters 2022 committed to creating additional capacity to help address current supply chain challenges through the increased use of rail. The company also pointed out that revenues for automotive transportation decreased due to lower North American vehicle production, which continues to be affected by shortages of semiconductors. Shares traded solidly lower.

Higher compensation costs have been a theme early on in Q4 earnings reporting season, and Schwab's Chief Investment Strategist Liz Ann Sonders notes in her latest article, We Can Work It Out: Update on Labor Market, the labor market remains tight—hence the stepped-up pace of balance sheet tapering by the Federal Reserve, and the market now expecting multiple rate hikes this year.

She provides one historical nugget of truth to keep in the back of your mind as the Fed embarks on its rate hiking cycle: in the post-WWII era, every time (12 occurrences) that the Fed was raising rates—and the three-month moving average of the unemployment rate rose by at least .35 percentage points—a recession has unfolded. For now, Liz Ann notes that the good news is that the unemployment rate continues to descend; but keen observers will understand the potential economic implications of an eventual turn back up—especially if rate hikes are still underway.

In other equity news, Dow member Intel Corporation (INTC $52) announced plans for an initial investment of more than $20.0 billion in the construction of two new leading-edge chip factories in Ohio. The company said the investment will help boost production to meet the surging demand for advanced semiconductors. Shares finished little changed.

Leading Economic Index posts tenth-straight monthly gain

The Conference Board's Leading Economic Index (LEI) (chart) for December rose 0.8% month-over-month (m/m), in line with the Bloomberg consensus estimate and above November's downwardly-revised 0.7% increase. The LEI was positive for the tenth-straight month due largely to the positive net contribution from building permits, jobless claims, the interest rate spread, and ISM new orders, while a dip in consumer expectations was the only component of the ten that was a drag on the index.

Treasuries were higher, as the yield on the 2-year note was down 5 basis points (bps) to 1.00%, the yield on the 10-year note decreased 8 bps to 1.75%, and the 30-year bond rate declined 7 bps to 2.07%.

The short end of the Treasury yield curve has continued to climb this week, with the rate on the 2-year note hitting the highest since March 2020, while the mid-to-long end has remained subdued, as the markets grapple with how aggressive the Fed will be in its response to combating surging inflation and what the implications on economic growth could be. Schwab's Chief Fixed Income Strategist, Kathy Jones notes in her latest article, The Fed's Policy Tightening Plan: A One-Two Punch, how beginning quantitative tightening soon after rate hikes is a big departure from the Federal Reserve's past policy.

Europe and Asia mostly fall as global markets remain volatile

European equities fell broadly, with value/cyclical stocks that have a higher weighting on this side of the pond leading to the downside. The markets remained uneasy regarding the ultimate impact on the economy of more aggressive monetary policy tightening to combat persisting inflation pressures. Materials and Industrials sectors saw noticeable declines, while the Energy sector trimmed a recent surge as crude oil prices came off the boil. Moreover, the implications of rising interest rates in the wake of the monetary policy tightening continued to ravage growth-related sectors, with Information Technology and Consumer Discretionary issues among the biggest decliners in the region. Schwab's Chief Global Investment Strategist Jeffrey Kleintop, CFA, discusses in his latest article, What Do Rising Rates Mean for Stock Investors?, how recently, U.S. Treasury bond yields climbed back to their pre-pandemic levels and in Europe, German 10-year yields climbed to near 0%, touching their highest level since May 2019. Jeff asks the question of what are the implications of rising global yields for stock prices? He points out that increasing yields could help lift stocks and may even signal outperformance of cyclical European stocks and value stocks.

In economic news, U.K. retail sales fell much more than anticipated for December, while a read on Eurozone consumer confidence showed a smaller-than-expected decline. The euro traded higher versus the U.S. dollar while the British pound came under some pressure, and bond yields in the Eurozone and the U.K. gave back recent rallies that saw Germany's benchmark 10-year bond flirt with moving out of negative territory this week. The U.K. FTSE 100 Index was down 1.2%, France's CAC-40 Index and Italy's FTSE MIB Index fell 1.8%, Germany's DAX Index dropped 1.9%, Spain's IBEX 35 Index declined 1.4%, and Switzerland's Swiss Market Index decreased 1.6%.

Stocks in Asia mostly finished with solid declines to close out the week, with the markets remaining on edge regarding the prospect that some major global central banks, led by the Fed in the U.S., may be forced to aggressively tighten monetary policy to combat persisting inflation pressures. Technology issues continued to fall on the prospect of higher interest rates, while the implications on economic growth also weighed on cyclical stocks in the region, notably Energy and Materials. The omicron variant also continued to fester and the recent response by China amid its zero tolerance policy has fostered concerns about the economic impact on the world's second-largest economy. However, this week China has responded by bucking the trend of other world central banks by loosening its monetary policy though multiple cuts to key interest rates to try to stabilize the economy. In economic news, Japan's December national consumer price inflation rose but at a smaller rate than expected, South Korea's January export growth accelerated, and Hong Kong's consumer price inflation accelerated at a slower rate than anticipated.

Schwab's Jeffrey Kleintop in his article, Top Global Risks of 2022, touches on how future COVID waves may not resemble those of 2021, while also offering four additional risks, in no particular order: shortages turn into gluts, rate hikes slower than expected, China goes from cracking down to propping up, and geopolitical surprises. Whether or not these risks come to pass remains to be seen, Jeff adds, but a new year almost always brings new surprises.

Japan's Nikkei 225 Index declined 0.9%, with the yen extending a recent rally versus the U.S. dollar. Elsewhere, China's Shanghai Composite Index also decreased 0.9%, South Korea's Kospi Index fell 1.0%, and India's S&P BSE Sensex 30 Index traded 0.7% lower. Australia's S&P/ASX 200 Index dropped 2.3%, to lead the declines in the region amid the heavy pressure on Energy and Materials issues. However, the Hong Kong Hang Seng Index ticked 0.1% higher to buck the trend.

Bearish new year continues

U.S. stocks fell for a third-straight week to continue the drawdown that accompanied the new year, with this week's losses the worst of the three, with the Nasdaq falling into correction territory, while the Dow and S&P 500 also registered noticeable drops. Concerns that the Fed may be forced to be more aggressive with its monetary policy tightening campaign due to persisting inflation pressures continued to drain conviction. Growth-related sectors—Consumer Discretionary, Information Technology, and Communications Services—which combined make up about 50% of the S&P 500, were the biggest drags on the markets as the prospect of rising interest rates threatened the present value of expected profits in the future. Moreover, the potential for the Fed to step on the policy tightening gas appeared to foster concerns that it may also put the breaks on the economic output to weigh on the cyclically-natured Industrials and Materials sectors. Energy issues, which have noticeably outperformed thus far this year—the only group in the green for 2022—trimmed some of their sizeable gains for the year amid the economic concerns that were exacerbated by the festering omicron variant, even as crude oil prices continued to rally, hitting seven-year highs this week.

Financials also were among the worst performers on the week, following mixed results from the heavyweights in the sector, as strong investment banking results were met with mixed reads on trading revenues and loan growth, while higher expenses due to rising compensations costs were a drag for most that reported. Volatility in the Treasury bond markets amid the grappling with Fed expectations also likely contributed to the pressure on the group. Although early, thus far for Q4 earnings season, of the 64 companies that have reported results in the S&P 500, roughly 70% have topped revenue forecasts, while approximately 78% have bested earnings expectations, per data compiled by Bloomberg.

Next week, as we return to a full calendar, the ramping up of earnings season will likely command attention as the markets look to see if the results will provide a reprieve from the downside pressure we have seen. Not to be outdone, next week's economic docket is poised to compete for market attention, with the first look (three) at Q4 GDP, January reads on Consumer Confidence and Manufacturing and Services PMIs from Markit, initial jobless claims for the week ended January 22, and the Q4 Employment Cost Index. Other reports due out that deserve a mention include, preliminary December durable goods orders, and the December personal income and spending report—which will include a look at the Fed's favored gauge of inflation, the PCE Price Index. However, the midweek monetary policy decision from the Federal Open Market Committee (FOMC) is likely going to be the biggest driver of market action. The FOMC is not expected to announce any change to its target for the fed funds rate, but the statement could be highly scrutinized for any clues to how aggressive the Central Bank is planning to be. Given the hyper-sensitivity that markets have been to the timing of the Fed, the customary press conference by Chairman Jerome Powell shortly after the announcement could foster the most market-moving potential as his prepared remarks will be followed by a Q&A session.

Next week's international economic calendar will be highlighted by several preliminary Manufacturing and Services PMIs from the likes of Australia, Japan, the Eurozone and the U.K. Other releases that may grab attention could include: Australia—consumer price inflation statistics. China—industrial profits. Japan—Tokyo consumer price inflation for January. Eurozone—economic confidence, as well as German January business confidence, February consumer confidence, and the preliminary read on Q4 GDP. As noted in our latest Schwab Market Perspective: Bumps in the Road, the effects of the COVID-19 virus have continued to drive—and brake—economic growth. Stocks sank in early January as investors reacted to the fast-spreading omicron variant and the Federal Reserve’s signals around inflation, including the possibility it will begin “quantitative tightening” much faster than previously expected. However, there are signs that inflation pressures already may be peaking in the United States and Europe.

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