Santa’s sleigh hit a serious air pocket almost immediately after Wednesday’s takeoff. Market turbulence is a real thing. The Santa Rally hit a snag. Mr. Claus and his reindeer are dealing with some serious motion sickness. But they know what to do.
This was an important week, with the Fed meeting squarely centered on the calendar, which was expected to bring a liftoff to the speed of the central bank’s taper. You may recall it is a big deal that the Fed is reducing its monthly asset purchases, which were implemented as an emergency measure in response to the Covid crash last year. In plain language, they are buying fewer Treasuries and Mortgage-Backed Securities per month, but still buying, which enhances the liquidity of the financial system. These routine purchases contributed mightily to the massive increase in asset prices in America. Stocks and houses are atop the list, which also includes art, cryptocurrencies and baseball cards, among others.
The Fed brought exactly what the Market wanted on Wednesday. It was a Goldilocks delivery by the central bank; Not too hawkish, not too dovish. They threaded the needle just right. Fed Chair Powell retired the term transitory in describing today’s inflation at the last meeting, and started emphasizing the other side of his dual mandate “stable prices” over “maximum employment.” The taper will be expedited as expected. Rate hikes will happen next year, but likely not until Summer. Monetary policy will be data-driven. The Market likes it. That provided the fuel for a Santa Claus rally, which often takes off on December 15. Wednesday was the best Fed Day session in over a year. That’s saying something. The Market loves certainty. It just didn’t last. Sellers quickly jumped back in.
The Fed trimmed its forecast for US Economic growth this year to 5.5%. They modeled 5.9% before. But they increased their expectations for 2022, anticipating the Economy to grow 4.0% next year. 2023 is looking like a return to 2% growth, the consistent level achieved pre-Covid. Despite the Fed asserting itself with a clear plan to tame inflation, the Market keeps recalibrating risks and rewards ahead. There’s still that virus. Omicron is trying to steal Christmas. But growth is still strong. Americans are out and about spending. Demand continues to outstrip supply, pretty much everywhere. The more rapidly spreading Omicron variant is showing signs of less virulence. People throughout the country and around the world seem to be proceeding with different degrees of caution. That’s been the way for 20 months now. But the Market has had the same approach; Initial shock to the system followed by a seeming view of vaccines over virus. That still seems to be the case as studies show booster shots are proving effective.
Retail sales grew at a slower clip than expected in November. Many saw that as a sign of an economic slowdown. Perhaps, but we believe Americans started shopping early due to the well-telegraphed supply constraints. Shoppers were told early and often, if you see it and you want, buy it, because it might not be there later. The lights went dark this week on Broadway and many Manhattan restaurants closed due to the increased Covid spread. But the Florida Keys are expecting their busiest Holiday season ever. The rest of the country lies somewhere in between with economic activity. Consumers keep spending but continue to face higher prices.
Back to the Market: The Tech-heavy Nasdaq fell 3% on the week. Rate-sensitive Growth stocks fell sharply as future cash flows are worth less when inflation and interest rates rise. Escalator up, elevator down. It’s the Market way. Even the highly profitable, cash heavy Tech Titans got hit. That’s new. It also could be a sign that pretty much every segment of the Stock Market has now experienced selling, which can result in capitulation. That sets up an environment now of a large population of future buyers. After hitting 67 new highs this year for the S&P 500, investors were fully weighted and getting downright giddy before Thanksgiving. The shine came off in November and has continued in December. This week was like a rolling correction from Growth to Value, from Aggressive to Defensive. It’s actually been that way all year. The Tech Titans have masked the corrective price action below the surface. It finally caught up.
Emerging markets showed some signs of a turnaround this week. We are interested to see if they can start to reaccelerate to enter 2022. Emerging market returns are negative on the year, while International markets are up ever so slightly. Global equities have diverged wildly from US markets in ’21. We anticipate a catch-up in 2022 and beyond; we remain open minded.
The Market behavior with this heightened volatility the last few weeks has scared investors big time. Investor sentiment is lying near Covid lows. Sentiment usually sours near lows. Exuberance and excesses have been shaved. Corrections do just that. We actually found Friday’s price action compelling. Many stocks and indexes are hitting higher lows. That is a really good sign for a Market getting ready to stop going down. I know it sounds simplistic, because it is. Before a rally ensues, things have to stop declining. Backing and filling is a healthy part of a strong uptrend. It tests and uncovers price discovery, which is the best way to find true value. Buyers are stepping in at higher prices than they did in November. Areas that were beaten up the most saw strength to close out the week. That’s important.
There was another factor at play this week which contributed to the volatile price action. Friday was a Quadruple Witch. That’s when all 4 sets of options expire simultaneously. All stock index futures, stock index options, stock options, and single stock futures saw their December contracts expire. It created a surge in volume as traders re-position their bets for future events. Trading volume was 50% greater today than average. It can skew things a bit, but once it’s over, the table could be set for a smoother finish to another eventful year. That’s what we are looking for, a series of really uneventful, dare I say boring trading days to close out 2021.
The Market continues to deal with a lot of moving pieces. This is normally the strongest season for stocks. It has definitely not played out that way. Besides, what’s normal these days anyway? A Santa Rally could definitely ensue next week into year-end. We see that happening as indicators and price action noted above supports the thesis. But we are under no false pretenses that more trouble could be ahead. We actually believe that to be true. We just think it is pushed out into early in 2022, a time we plan to get much more defensive. The Covid environment is tough to navigate. As always, when the facts change, so do we.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
