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4th Wave — Week of December 20, 2021

Written by Steve Orr, Chief Investment Officer, and Mark Frears, Investment Advisor

index wtd ytd 1-year 3-year 5-year index level
S&P 500 Index -1.91 24.71 26.62 24.10 17.51 4,620.64
Dow Jones Industrial Average -1.67 17.71 19.47 16.96 14.78 35,365.44
Russell 2000 Small Cap -1.68 11.08 12.40 17.85 11.15 2,173.93
NASDAQ Composite -2.94 18.48 20.66 32.15 24.00 15,169.68
MSCI Europe, Australasia & Far East 0.48 10.10 11.42 12.99 10.02 2,300.38
MSCI Emerging Markets -1.14 -3.18 -0.77 11.00 10.26 1,223.89
Barclays U.S. Aggregate Bond Index 0.20 -1.48 -1.18 5.07 3.81 2,356.65
Merrill Lynch Intermediate Municipal 0.05 0.89 1.01 4.44 3.91 319.93

As of market close December 17, 2021. Returns in percent.

4th Wave

Pick your market Scrooge today: omicron, the Fed, Congress, Chile, or all the above. Global omicron case counts are forming a fourth wave of the COVID-19 virus as the strain overtakes delta in many places. Shutdowns or “pauses” are being talked about in many countries in Europe. The Netherlands yesterday became the first EU country to re-enter a nationwide lockdown. Ireland imposed an 8pm curfew for restaurants and Germany tightened travel restrictions. According to the New York Times, the delta variant remains the largest source of infections in the U.S., but omicron is causing steep jumps in cases in the northeast. Cancelling performances and postponing hockey games are shifting sentiment into Risk-Off mode. Midday Monday, stocks are down between 1.2% and 1.5%.

The Fed’s bond buying program was front and center for traders last week. Members of the Fed’s Open Market Committee voted to accelerate the wind down of the Fed’s bond buying program. Tough inflation numbers and a dwindling supply of workers pushed the Fed to admit that this 2020 pandemic support program was no longer needed. More details below. 

Late last week Senator Manchin (D-WVa) told Fox News that he would not support the Administration’s Build Back Better $1.9 trillion spending plan. That effectively put the negotiations among Senators on ice until January. Most investors assumed that somewhere in those 2,000 pages there were monies available that could boost earnings and stocks. We are at the beginning of the end of monetary stimulus (Fed) and fiscal stimulus (Congress). 

In Chile, a former student protest leader won the presidential election. Gabriel Boric promised to scrap mining initiatives, raise taxes and end private pensions. The possibility of lower supplies of copper and other metals made traders nervous. How about buybacks? U.S. companies have spent over $200 billion each quarter this year buying back their own stock. Many of these plans have blackout windows that prevent companies from buying in the days or weeks before their earnings announcements. The calendar tells us that blackouts are ramping up for first quarter earnings, which removes a measure of support for stocks. 

Combined, these Scrooges have dampened holiday spirits and sent the major indices back down into their recent trading ranges. What does this mean for our client portfolios? All our economic and earnings indicators are green, and valuations are slowly improving. Companies and consumers are in their best shape in decades. The Conference Board’s Leading Economic Index rose the most in six months in November. The coincident index, a monthly measure of current activity, continues to rise. The market trend and sentiment are neutral to weak. Adding it all up, the economy and company earnings can likely weather another virus slowdown.


Back to central banking for a moment. Following the playbook announced last year, the Fed did not change short-term interest rates. The plan is to finish the bond buying program before raising rates. The acceleration of the wind down means the program should end in the spring. Fed Funds futures are then pricing quarter point increases in May, September and December. This suggests an overnight rate at the end of December of 0.75%. That level should in turn push two-year Treasury notes to roughly 2% and 10-year notes closer to 3%, levels last seen in 2019. 

The Fed’s tests for raising short-term rates are 1) inflation “averaging 2% for some period of time,” and 2) “full employment.” The Fed would like to believe the supply chain issues created “transitory” inflation. Absent fiscal spending by Congress, that may have been the case. Prices rising almost 10% across the board, housing nearly 30% in some places and energy 50% higher has the Fed’s attention. So put a check mark by #1. 

Full employment remains an enigma to Fed watchers. In his press conference today, Chairman Powell acknowledged that rising wages and record-high quit rates are good signals for full employment. Wages are rising but not keeping pace with inflation. Quit rates are at all-time highs because plenty of other jobs are available. We would also add retiring Baby Boomers are lowering the available pool of workers, making comparisons of labor force participation to pre-pandemic levels difficult. We believe we are close to “full employment.” Those projected rate increases should set the stage for higher rates later in 2022. 

Wholesale Inflation

Commodity and wholesale goods prices started moving higher last fall. Like many prior recoveries, early inflation in this recovery cycle was driven by supply chain and reopening demand. Since March of this year, inflation has broadened to almost every sector of the economy. 

November producer prices are running at a 9.6% rate over last November. Consumer prices have accelerated since March, averaging 5.45% per month, rising at a 6.8% rate over November 2020. As Chairman Powell stated in the press conference, “This is not the inflation we were looking for.” 

March marked the pivot month for consumer prices, thanks to Congress distributing $1.9 trillion directly to consumers and governments. In the decade leading up to March 2021, consumer inflation averaged 1.6%.

Retail Sales – Consumer

Consumer purchases for November came in lower than expected, although given the economic headlines, this is not out of line. The concerns surrounding declining government aid, COVID impact, and higher priced goods are causing consumers to hesitate. Discretionary retail sales (excluding grocery store and gas station purchases) were flat on the month, but YoY is still advancing at double digit rates.  Consumer demand is still on a positive trend going into 2022. We will be watching Consumer Spending later this month to see if the trend in purchases of services over goods continues. This also is a good sign for a strong economy.

The consumer is two-thirds of GDP, so we watch them closely. The University of Michigan Consumer Sentiment indicator for early December showed a few new trends. First, the sentiment improvement in the cohort of lowest third of incomes was significantly higher than middle and upper. They are more confident in their ability to find employment now, and potential for higher wages as well. Second, there is now a substantial gap between consumers' evaluation of current and prospective financial situations. For now, they see good prospects for jobs, but the view of the future is not as bright, with inflation taking away from their buying power.  

Wrap Up

Markets for all assets are rethinking central bank help. Remember almost all the bond buying programs around the world were a response to pandemic shutdowns. The U.S. had by far the most aggressive response, from both the Fed and Congress. That is a principal reason why the U.S. led the way out of reopening and into recovery. Now that a new faster variant has entered the Vaccine vs Virus war, traders are rightly concerned that more slowdowns are on offer. Moves in all markets over this week and next are magnified thanks to seasonal vacations. We understand their short-term concerns but are cognizant of our medium and long-term indicators that still shine green

Steve Orr is the Executive Vice President and Chief Investment Officer for Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary’s University School of Law. Follow him on Twitter here.  Mark Frears is an Investment Advisor at Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Science from The University of Washington, and an MBA from University of Texas - Dallas.

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