Stocks trade lower in wake of Powell nomination, Europe’s Covid surge

Morning Note

After a kneejerk bounce to fresh all-time highs, stocks on Wall Street ended the day lower as investors decided that Jay Powell is likely to tighten monetary policy more swiftly than Lael Brainard would have done. Quite how the market is reading so much into this reappointment is kind of hard to work out. Bond yields ticked up, with the policy-sensitive 2yr note rising to its highest since March 2020; the dollar rose to a new 16-month high and has held gains as of this morning; gold tumbled as yields climbed; financials and energy rose and tech stocks fell, dragging the broad market lower. Cyclicals helped the Dow Jones hold on to a tiny gain. European stocks have fallen this morning following the weaker US session, whilst the Covid spread is another factor likely weighing on sentiment. Reasonably upbeat PMIs this morning don’t reflect the shift in Europe we have seen over the last fortnight. Bond markets remain under pressure this morning with the US 2yr note trading at 0.63%, having yesterday jumped 8bps to 0.58%.

 

Markets now price in a full 25bps hike by June 2022. Are markets right to think the Fed is suddenly going to be more hawkish? Richard Clarida suggested last week the Fed could speed up the pace of its tapering – was this more of a signal shift than at first assumed? Yesterday Powell seemed to flag inflation as a concern: “We know that high inflation takes a toll on families… We will use our tools… to prevent inflation from becoming entrenched.”

 

As noted yesterday, the hawkish reaction to the news seemed odd, for a couple of reasons. Firstly, Powell has hardly been a hawk and the appointment means continuity; secondly the odds on Brainard were quite long. Nevertheless, the market seems to have taken the Powell nomination as something of a signal; broadly speaking we might say that the Fed and, more importantly maybe the White House, are starting to recognise the danger of inflation the longer it stays high. Janet Yellen, Treasury Secretary, told CNBC that inflation has reached a level that “concerns most Americans” and that the Fed needs to play an important role to make sure that inflation “doesn’t become endemic”. I guess we could be in the middle of a policy adjustment of sorts, but it’s mainly tinkering at the margins – whether the Fed hikes by June or July is kind of irrelevant. We must also consider a degree of ongoing uncertainty around a number of open governor and regional chair positions, which makes the outlook for 2022 a little harder to read than usual. Ultimately I don’t see how the Powell-led Fed is more hawkish today than it was last week, but we should always beware linear thinking: even the Fed can adapt and learn from the persistently high inflation. You never know perhaps the Fed – and the White House – are starting to heed some warnings about what untethered inflation can do. In summary, you could say there’s been a whiff of a hawkish tilt at the Fed in recent weeks and the administration is OK with that.

 

Crude remains under pressure, with WTI taking a $75 handle, as the US and other nations are set to release oil from strategic reserves to cool prices. Although such moves are unlikely to exert much of a long-term influence on prices, there is already worries about oversupply into the year end and start of 2022. Rising covid cases and new restrictions are a factor. OPEC+ could adjust its production plan to absorb the excess crude from strategic reserves, but it’s unclear as yet what they plan to do.

 

Profits warnings seldom come alone: AO World shares fell by a quarter after a sharp downgrade to guidance issued only two months ago, which was a also downgrade.  The company warned that growth in the UK has been impacted by the shortage of delivery drivers and the ongoing disruption in the global supply chain, whilst Germany has seen significantly increased competition. Availability of some new products is poor and inflation is biting with higher shipping costs, material input prices. As a result, management warn that current peak trading period is “significantly softer” than was anticipated only eight weeks ago. Full year group revenue is now guided to be flat to -5% year on year, with group adjusted EBITDA in the range of £10m to £20m. As noted of this stock in Oct, it needs high double-digit revenue growth. Margins in a highly commoditized business are wafer thin at the best of times. Now supply chain woes coupled with a shortage of drivers creates some serious headwinds for the stock, which benefitted greatly from the surge in online demand last year. It now faces some new challenges which seem set to perform the double trick of hammering margins and lowering revenue growth. 

 

Pets at Home shares rose on a decent set of interim results as the company posted group like-for-like (LFL) revenue growth of 22.2%, or 28.6% on a 2-year basis. Total group revenue growth of 18% to £677.6m. Profit before tax rose 77.2% to £70.2m, with growth of 68.3% on a 2-year basis. Free cash is up more than 50% to almost £92m. Basically, everyone was bored in lockdown and bought a puppy and most people have been decent enough human beings to continue to look after them. Or as management put it today: “The stronger than expected and continuing growth in the pet population over the past eighteen months is materially increasing the size of our addressable market.” 

 

Shares in Compass Group fell despite the company saying it should be back to pre-Covid operating margins next year. Margins improved to 5.8% in the fourth quarter (4.5% for the FY) and the company said it anticipates FY22 underlying operating margin to be over 6%, hitting 7% by the end of the year. Still revenues are stubbornly low despite the Healthcare & Senior Living and Defence, Offshore & Remote sectors performing well above pre-pandemic volumes. Underlying revenue recovered to 88% of 2019 revenue by Q4. FY underlying revenue is at 77% of 2019. Still nursing the lingering effects of the pandemic – a long Covid sufferer as people, particularly in business, office work, spend less time face to face.