Return — Week of December 13, 2021
Written by Steve Orr, Chief Investment Officer, and Mark Frears, Investment Advisor
|S&P 500 Index||3.85||27.14||30.13||23.46||17.96||4,712.02|
|Dow Jones Industrial Average||4.05||19.71||21.88||16.28||15.27||35,970.99|
|Russell 2000 Small Cap||2.45||12.97||17.40||16.73||11.15||2,211.81|
|MSCI Europe, Australasia & Far East||2.74||9.89||12.40||13.26||9.86||2,296.30|
|MSCI Emerging Markets||1.90||-1.34||1.77||11.90||10.13||1,247.71|
|Barclays U.S. Aggregate Bond Index||-0.71||-1.67||-1.10||5.08||3.64||2,352.18|
|Merrill Lynch Intermediate Municipal||-0.03||0.82||1.14||4.41||3.77||319.73|
As of market close December 10, 2021. Returns in percent.
Stocks halted a four-week consolidation last week with a strong push higher on Monday and Tuesday. Plenty of fundamental and technical drivers were on display but the two most important were omicron and trend resistance. Markets took stock of early impacts from the new virus variant and decided existing treatments and vaccines may get the job done. The S&P 500 returned to a new high, finally closing above 4,700.
Omicron’s impact over the last month beat down small and mid-cap stocks. Value and cyclicals also were punished as traders moved back to “shutdown” themes. As omicron fears faded over the last two trading days, we have seen a sharp rotation back to big tech, industrial and, gasp, energy names.
The correction drop of 4% on the S&P 500 washed out overbought positions and pushed the index back down to its 21-day moving average on the weekly chart and below its 50-day moving average on the daily charts. These fast moves reset many statistical indicators and investor sentiment to bullish levels.
Economies around the globe continue to expand. Purchasing manager surveys from IHS Markit and ISM show new orders, hiring and overall activity rising month over month. Unfortunately, prices paid and wages are increasing at some of their fastest rates in decades.
The labor market is a key front in the Vaccines vs Virus war. Jobless Claims (people filing for unemployment benefits) last week hit the lowest level since 1969, indicating that more of the population is back to work. We expected claims to fall as COVID benefit programs expired, and this seems to be occurring.
At the same time, the Job Openings and Labor Turnover Survey (JOLTS) for October showed 11 million job openings! The industries with the most openings are accommodation and food services, nondurable goods manufacturing and educational services. The costs for retaining and attracting new employees will be an additional cost to doing business. Low claims combined with high job openings are a recipe for labor market stress and ultimately higher wages.
The Consumer Price Index (CPI) release last Friday was watched with Christmas-morning type expectations. November’s price increases met expectations, hitting a 39-year high of 6.8%. Consumer prices have averaged increases of 5.75% over the last six months.
Monthly numbers continue to be highly influenced by used car prices, up 2.5%, but lower than the 4% print in October. Core goods, which leave out autos and food, rose 0.6%, versus 0.8% in October. Shelter costs rose 0.5% for the month. Shelter consists of apartment rents and an unusual measure of home prices called homeowner’s equivalent rent. Together rents and equivalent rent make up 30% of overall CPI. Housing costs figure into CPI on a six-month lag, so all those roaring house prices you have heard about are just now making their way into the CPI numbers.
Supply chain disruption is a major driver of the inflation tsunami. There is plenty of cash chasing too few goods. Housing prices hit CPI on a six-month lag and are just now starting to impact readings. Winter should slow activity some, allowing builders to build up some inventory. The third wave is wages. Prime age workers (24 to 54 years) are not returning to work as fast as was expected. There are several COVID-induced factors at play here, and this wave could provide more lasting impact on inflation.
The Fed’s Open Market Committee, generally referred to as the “Fed,” meets tomorrow and Wednesday. The consensus on the Street is that members will vote to accelerate the timetable for reducing the Fed’s bond buying program. The Committee has stuck by its “process,” saying that it needs to finish its pandemic bond buying program (“Quantitative Easing”) before considering raising rates. The current timeline has the program wrapping up in the summer.
Commentators say moving up the end date for QE taper would give the Fed more flexibility in deciding when to raise rates. We would remind our readers of a couple of important points. First, post Greenspan the Fed has not raised rates ahead of the market. Fed funds futures markets are moving up the date for the first-rate increase. They are now projecting May 2022 instead of July two months ago.
Second, the Fed has a well-earned reputation for being late to raise rates in an economic cycle. In prior cycles activity would have peaked or just rolled over and the Fed’s interest rate increases would have just amplified the downswing. The extremely compressed business cycle of 2019-2020 will be analyzed for generations. Price increases caused by supply chain shocks and amplified by fiscal policy (those direct stimulus payments) in the CARES Act will be Exhibit 1. Zero interest rates and accommodative policies by the Fed added fuel to this cycle’s price moves.
Going back to Milton Friedman’s quote about inflation being a monetary phenomenon, putting money directly into folks' pockets stimulates demand in the short-term. The stimulus heightened the supply chain and labor problems and will likely lead to permanently higher prices in many sectors. The University of Michigan surveys and global rates markets are fairly accurate at predicting inflation. They are still forecasting lower levels three and five years from now.
The economy will slow down next year. The rapid recovery in 2020 slowed to above-trend expansion in late 2021. In the prior decade, the U.S. economy grew close to 2% and inflation ran at 1.5%. Those levels are consistent with our high level of national debt and low birth rate. How quickly we get back down to 2% trend growth is the trillion-dollar question. Year-over-year growth rates in the economy and prices will slow next year. GDP growth this year should end up north of 5.5%. Next year’s 4% growth will be a drop from 2021 but remember that is more than double the growth over the last decade.
We think it is even odds as to whether the Fed will vote to change its bond buying program Wednesday. If the Committee does vote to accelerate the end of QE bond buying, it will hinge on those jobless claims and employment figures. “Full employment,” as defined by the Fed, is their test for raising rates later next year. If they wait until January’s meeting, they will have another jobs and inflation report in hand. If the Fed continues to buy bonds and not raise rates, the yield curve will remain relatively flat (short term and long-term yields very similar), and inflation could stay higher for longer.
We would like to think the post-pandemic expansion is underway. New variants keep diverting our attention, but we are encouraged by the early case reports on omicron. Markets are turning their attention to the Fed. The Fed always seems to raise rates too late in an expansion, adding to the downturn. This inflation cycle was started by supply chain problems but sustained by easy money policies.
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 a MBA from University of Texas - Dallas.
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