• Charles Schwab and Co.

Geopolitical Anxiety Hampers Conviction



U.S. equities finished lower ahead of the long holiday weekend, posting losses for a second-straight week, as geopolitical concerns remained the main negative catalyst on the heels of conflicting claims regarding a potential imminent attack by Russia on Ukraine. The moves came despite news that Secretary of State Antony Blinken is expected to meet with Russian Foreign Minister Sergey Lavrov next week. Elevated expectations that global monetary policies will tighten this year added to the negative sentiment, with the Fed set to begin its rate hike campaign next month. Earnings season continued to roll on, with Deere & Company delivering upbeat results and guidance, while Roku and DraftKings fell on their reports, and GE warned about supply chain, labor and inflation pressures. The economic calendar offered some mixed data, with leading indicators snapping a long positive streak, while existing home sales surprisingly jumped. Treasuries were higher to apply some downside pressure on yields, while the U.S. dollar rose, and gold dipped after a recent rally. Crude oil prices ticked higher despite the geopolitical concerns, as a potential Iran deal that is expected to be discussed this weekend pushed oil to post its first weekly decline in two months. Markets in Europe and Asia were lower amid the Russia/Ukraine uncertainty.

The Dow Jones Industrial Average declined 233 points (0.7%) to 34,079, the S&P 500 Index shed 31 points (0.7%) to 4,349, and the Nasdaq Composite decreased 169 points (1.2%) to 13,548. In heavy volume, 4.6 billion shares of NYSE-listed stocks were traded, and 4.4 billion shares changed hands on the Nasdaq. WTI crude oil nudged $0.17 higher to $90.21 per barrel. Elsewhere, the gold spot price traded $4.20 lower to $1,897.80 per ounce, and the Dollar Index—a comparison of the U.S. dollar to six major world currencies—was up 0.3% at 96.08. Markets were lower for a second week in a row, as the DJIA was down 1.9%, the S&P 500 lost 1.6%, and the Nasdaq Composite fell 1.8%. Deere & Company (DE $369) reported fiscal Q1 earnings-per-share (EPS) of $2.92, above the $2.27 FactSet estimate, as net equipment sales grew 6.0% year-over-year (y/y) to $8.5 billion, exceeding the Street's forecast of $8.3 billion. DE said its end-market demand for farm and construction equipment was favorable, while it is leveraging technology that delivers improved customer profitability, productivity, and sustainability. The company said its Q1 performance was impressive given production issues surrounding the delayed ratification of its UAW contract in late November as well as persistent challenges posed by the supply chain and pandemic. DE said these factors led to higher production costs, and it continues to work closely with key suppliers to manage the situation. The company raised its full-year earnings guidance, noting that end-market demand remains favorable. Separately, DE announced new goals known as Leap Ambitions, designed to create value for its customers and other stakeholders. Shares finished lower in choppy trading.

Roku Inc. (ROKU $112) posted adjusted Q4 earnings before interest, taxes, depreciation, and amortization (EBITDA) of $86.7 million, above the forecasted $76.3 million, with revenues rising 33.0% y/y to $865.3 million, below the $894.0 million expectation. The steaming-video company's active accounts came in just above estimates, but its average revenue per user (ARPU) on a trailing twelve-month basis was below expectations. ROKU cited disruptions from supply chain challenges and softening advertising trends, while issuing Q1 EBITDA and revenue guidance that was below expectations. Shares tumbled over 20%.

DraftKings Inc. (DKNG $17) announced an adjusted Q4 EBITDA loss of $128.0 million, compared to the $150.7 million shortfall that was anticipated, on revenues of $473.0 million, which were up 47.0% y/y, versus the projected $446.0 million. DKNG's monthly unique players came in at 1.97 million, which fell short of the estimated 2.12 million. The company raised its full-year revenue guidance slightly but issued an adjusted EBITDA loss forecast that was larger than expected, as it plans to spend heavily to try to attract new customers. DKNG said its guidance reflects the launch of mobile sports betting in New York and Louisiana, and it expects to be contribution profit positive for the year across all states where it is currently live including New York and Louisiana. Shares fell nearly 20%.

Shares of General Electric Company (GE $93) came under pressure after the company offered an update, "In light of recent commentary from other companies, a number of investors and analysts have been asking us for additional color about what we are seeing so far in Q1." GE said while it is seeing progress on its strategic priorities, it continues to see supply chain pressure across most of its businesses as material and labor availability and inflation are affecting its healthcare, renewable energy, and aviation units. The company added that it expects these challenges to persist at least through the first half of the year and the magnitude of these challenges likely present pressure to overall growth, profit, and free cash flow beyond typically expected seasonality.

As Q4 earnings season heads down the home stretch, of the 419 companies that have reported results in the S&P 500, 69.62% have topped revenue forecasts, while 76.79% have bested earnings expectations, per data compiled by Bloomberg. Compared to last year, revenue growth is on pace to be up 15.79% and earnings expansion is on track for 27.41%.

The markets have seen some wild swings as the markets grapple with the Fed tightening uncertainty and still solid absolute earnings growth during the quarter but some relative deterioration compared to the previous four quarters. Schwab's Chief Investment Strategist Liz Ann Sonders notes in her article, Smoke on the Water … Fire Down Below, how results have bucked the trends of the past six quarters—with a lower percentage by which companies have been exceeding consensus estimates. As for Fed policy, Liz Ann adds that as has nearly always been the case historically, a shift in the monetary policy backdrop can mark significant turning points in the equity market and typically lead to more frequent bouts of volatility. Liz Ann also notes how the much stronger-than-expected January nonfarm payroll report likely confirmed the Fed's full-steam ahead message for the near term in her latest commentary, Surprise, Surprise: Jobs Surged.

With the markets volatile, find all our market commentary on our Market Insights page, including our article, Market Volatility: Schwab's Quick Take, and follow us on Twitter at @SchwabResearch.

Leading Indicators snap positive streak, existing home sales surprisingly jump The Conference Board's Leading Economic Index(LEI) (chart) for January declined 0.3% month-over-month (m/m), compared to the Bloomberg consensus estimate calling for a 0.2% gain, and following December's negatively-revised 0.7% increase. The LEI was negative m/m for the first time since February 2021, due largely to the negative net contributions from jobless claims, consumer expectations, stock prices, and average workweek, which more than offset positive reads for the interest rate spread and ISM new orders.

Existing home sales jumped unexpectedly by 6.7% m/m in January to an annual rate of 6.5 million units, versus expectations of 6.1 million units, which would have matched December's downwardly-revised rate. Existing home sales were higher in each of the major U.S. regions, while y/y sales were mixed as the Northeast and West saw declines, the South saw a modest increase, and the Midwest was flat. Sales of single-family homes jumped m/m but were down y/y, while purchases of condominiums and co-ops also rose m/m and declined from the prior year. The median existing home price was up 15.4% from a year ago to $350,300, marking the 119thstraight month of y/y gains as prices rose in each region. Unsold inventory was at a 1.6-months pace at the current sales rate, down from the from the 1.9-months pace a year earlier. Existing home sales account for a large majority of the home sales market and reflect contract closings instead of signings so this report may not reflect the recent jump in interest rates.

National Association of Realtors Chief Economist Lawrence Yun said, "Buyers were likely anticipating further rate increases and locking-in at the low rates, and investors added to overall demand with all-cash offers …. Consequently, housing prices continue to move solidly higher."

Treasuries were higher as choppiness remained, as the yield on the 2-year note was down 1 basis point (bp) at 1.47%, the yield on the 10-year note declined 4 bps to 1.93%, and the 30-year bond rate decreased 7 bps to 2.25%.

Treasury yields have moved higher as of late, with rates on the short-end of the curve decisively outpacing the moves on the mid-to-longer end, resulting in a dramatic narrowing of the spread between the 2-year note yield and the rate on the benchmark 10-year note. Expectations have been solidified by the Fed that it will tighten monetary policy aggressively through multiple rates hikes beginning in March. However, the markets have been volatile as they contemplate what the implications could be as uncertainty festers regarding whether the Central Bank will go against its historical norm of 25 bp hikes and opt for a 50 bp increase at some point. Moreover, the Fed has said it would also accompany this year's rate increases with efforts to shrink its more than $8 trillion balance sheet.

Schwab's Chief Fixed Income Strategist, Kathy Jones points out in her latest article, Bond Market: Waiting for Liftoff, that we expect turbulence to continue as Fed Chair Powell indicated that policy plans are not on a set course, with the Fed preferring to take a "nimble" approach. However, she adds that the markets have discounted a significant tightening in policy for this year, with the telltale signs of tight policy expectations already showing up in the markets. Kathy discusses how the yield curve has flattened, with short-term rates moving up sharply relative to long-term rates.

Kathy says while it's clear that the Fed is anxious to initiate a new tightening cycle, we think it's premature to forecast such a rapid pace of rate hikes without more clarity about its plans to reduce the amount of bonds the Fed holds on its balance sheet. The Fed released general principles for quantitative tightening but hasn't spelled out a clear plan yet. She notes how allowing bonds to mature without reinvestment can have a similar impact as hiking rates in terms of the impact on the availability of funds to the banking system. She adds that the Fed has indicated it prefers using the federal funds rate as its primary tool to set policy, but given the size of its current bond holdings, it's possible that quantitative tightening will play a bigger role in the Fed's plans in this cycle than it did in the last cycle.

Europe falls, Asia mostly lower following data and the geopolitical uncertainties

European equities finished the week lower, with the markets continuing to monitor geopolitical concerns regarding Russia's intentions by massing troops on the Ukraine border. Uncertainty ramped up to amplify volatility, as Russia contends it does not intend to invade Ukraine and that it has withdrawn some troops from the border, while the U.S. has continued to warn that an invasion may be imminent. The uncertainty persisted despite news that after U.S. Secretary of State Antony Blinken made an urgent repeal to the United Nations he is expected to meet with Russian Foreign Minister Sergey Lavrov next week. Schwab's Chief Global Investment Strategist Jeffrey Kleintop, CFA, provides his Guide to Geopolitical Risk: Russia-Ukraine, where he discusses how markets have historically shrugged off geopolitical events involving Russia. He notes that Russia makes up a very small portion of the main global and emerging market indexes, while Ukraine has no exposure in such indexes. He discusses the most likely sanctions that may occur if the situation escalates, but he doesn't believe that diversified investors need to take action to protect their portfolios from the risks related to an invasion of Ukraine.

Meanwhile, the global markets continue to grapple with the prospect of tighter monetary policies on both sides of the pond. The expectations have been amplified by recent January inflation reports out of the U.S., that have come after the Bank of England (BoE) increased rates for a second straight meeting earlier this month, and the European Central Bank (ECB) sounded a more hawkish tone following its meeting in early February. The economic calendar is in focus and painting a mixed picture, with U.K. retail sales growing more than expected in January, while eurozone construction output fell in December. Elsewhere, Eurozone consumer sentiment declined, whereas economists were looking for a slight improvement. The euro and British pound were lower versus the U.S. dollar.

The U.K. FTSE 100 Index and France's CAC-40 Index were down 0.3%, Germany's DAX Index dropped 1.5%, Italy's FTSE MIB Index lost 0.6%, Switzerland's Swiss Market Index decreased 0.5%, and Spain's IBEX 35 Index declined 0.9%.

Stocks in Asia finished mixed as the global markets continue to grapple with conflicting reports regarding whether Russia is moving to de-escalate tensions with Ukraine, which it claims, or does an invasion remain imminent as the U.S. continued to suggest. Economic data was relatively light, though Japan reported that its national consumer price inflation slowed more than expected for January.

Meanwhile, the markets remained jittery regarding the elevated expectations for tighter global monetary policies as the Fed is set to begin hiking rates next month, while the Bank of England has already hiked rates at its last two meetings, and the European Central Bank has hinted it may increase rates later this year. However, the People's Bank of China has bucked the trend and moved towards looser monetary policy, while the Bank of Japan announced recently that it will buy its benchmark 10-year bonds for the first time since July 2018 in an attempt to keep rates from breaching its target range. Schwab's Jeffrey Kleintop discusses in his article, What Do Rising Rates Mean for Stock Investors?, 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. Also, Jeff makes the case of Why Invest Internationally?, by noting how a large home bias, even with international sales exposure, may not diversify investors across sectors, endangering financial goals when new economic cycles shift long term trends.

Japan's Nikkei 225 Index declined 0.4%, with the yen late in the session paring recent gains versus the U.S. dollar. The Hong Kong Hang Seng Index fell 1.9%, Australia's S&P/ASX 200 Index moved 1.0% to the downside, and India's S&P BSE Sensex 30 Index dipped 0.1%. However, South Korea's Kospi Index finished little changed, and China's Shanghai Composite Index bucked the trend, advancing 0.7%, as property stocks gained that Bloomberg noted came from reports that banks in several cities have cut mortgage down payments to try to revive struggling residential demand.

Stocks continue dismal start to the year

U.S. stocks continued the bearish theme that has accompanied the calendar turn to 2022, with the S&P 500 falling for a fifth week out of the seven we have seen this year. Grappling with how aggressive the Fed may be, beginning next month, with its monetary policy tightening campaign remained a major contributor to the volatility. However, the Fed uncertainty shared the spotlight with ramped-up geopolitical tensions as Russian troops remained near the border of Ukraine and the U.S. warned that an invasion could be imminent despite Russia's claims that has taken efforts to de-escalate the situation. The geopolitical front appeared to agitate worries about the potential impact on the ongoing global supply-chain challenges and the continued surge in inflation—as shown in this month's stronger-than-expected January consumer and producer price inflation reports—as Russia has a large impact on energy in the world, notably in Europe. These two sources of market skittishness overshadowed some upbeat economic reports in the form of larger-than-anticipated January retail sales and industrial production releases, as well as Q4 earnings season that is on pace to post the fourth-straight quarter of above 25.0% y/y growth.

Sector performance was mostly to the downside, led by Energy as crude oil prices fell for the first week in two months despite the heightened geopolitical concerns, and Financials as Treasury yields calmed down a bit after recent spikes. The lone sector in the green was the defensively-natured Consumer Staples, amid the exacerbated market uneasiness and following some upbeat earnings results from Dow member Walmart Inc. (WMT $138). The U.S dollar ticked higher but was mostly little changed in choppy trading this week but gold prices rallied.

Although shortened, next will still provide some data that could foster some market reaction, with Q4 earnings season continuing to wind down with a host of retailers putting the finishing touches on. Moreover, the economic calendar will offer some timely February data points, courtesy of preliminary Manufacturing and Services PMIs from Markit, as well as the Conference Board's February Consumer Confidence Index. Other economic reports due out next week that deserve a mention include, the first revision (of two) to Q4 GDP, January personal income and spending figures, initial jobless claims for the week ended February 19, and the final University of Michigan Consumer Sentiment Index. Some fedspeak will also be out and given the hyper-sensitivity of the markets to how fast the Fed may go with its monetary policy tightening campaign, commentary from these officials could also command attention.

Please note: All U.S. markets will be closed on Monday in observance of the Presidents' Day holiday.

Next week's international economic calendar will be dominated by a plethora of preliminary February Manufacturing and Services PMIs out of Australia, Japan, the Eurozone and the U.K. Other reports that may also contend for attention overseas include China's1-year and 5-year loan prime rate decisions, February Tokyo consumer price inflation figures, February Eurozone economic and industrial confidence reports, and German business sentiment for this month.

In our latest Schwab Market Perspective: Slipping Gears, we discuss how in recent weeks, it has felt like the U.S. stock market slips a gear every so often, dropping sharply as investors search for traction in uncertain terrain. Many of the individual stocks in the major U.S. stock indexes are down 20% or more from their peaks this year, creating the equivalent of a stealth bear market, even if the indexes themselves haven't hit that point. At the same time, investors are bracing for the Federal Reserve to start raising interest rates in March. Other major central banks are already doing so, representing a remarkable policy shift from only a few months ago. From a global perspective, although investors generally believe rising U.S. rates often lead to a downturn in emerging-market stocks, that isn't always the case. Meanwhile, the tense Russia-Ukraine situation has affected the Russian stock market, but if history is a guide, the impact is unlikely to spread.

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