Volatility is the Pattern. Recalibration is the Process. Expectations are the Key.

I sent out perhaps the longest Outlook piece I’ve ever written last week. I hope it held your interest and attention. There’s so much to cover as this young year takes shape. Next week we will be hosting our Outlook event to drill down further on the investment themes and action plans. We were hoping to do one in person again. It will be virtual. That’s just the way things are. 2022 has been eventful already. And Bedell Frazier has been active. I will keep things tighter today with another rapid rundown.

The week started with a sharp sell-off followed by an impressive reversal rally which gained momentum midweek. But that rally hit a wall on Thursday and selling followed thru into Friday morning before a late session rally sent the Stock Market into the holiday weekend near the flat line. If you hadn’t been watching, you’d think nothing was happening. You’d be wrong. So much is happening. Volatility is the pattern. Recalibration is the process. Expectations are the key.

Inflation remains the biggest issue for the Market, the White House and the Fed. Producer Prices, a major indicator for business, came in big for December. It increased 9.7% over the last year. Consumer Prices came in at 7%. Both were the highest increases in 4 decades. But most important, these results were less than expected. There is mounting evidence that many of the inflationary pressures we face have peaked. We don’t expect a material decline immediately, but the curve seems to be bending and lower prices seem likely. Not everywhere. The Labor Market is as tight as we’ve seen in a generation. Wages will likely stay elevated a little longer.

Interest rates have jumped significantly in this young year. The 10-Year Treasury started January below 1.5%. It hit a high of 1.8% last week. That might not seem like a big move, but it is. However, it’s not the rising rates that are causing the volatility. Rates are still low by historic standards. And they’re rising for the right reasons. The Economy is in solid shape and the Fed is merely removing the emergency measures it enacted during the Covid crash 22 months ago. The issue is really the velocity of the move that causes the turbulence. Ultimately, the Market is trying to price in where the Fed finishes its rate hikes. That’s the big question. The Fed doesn’t even know the answer. But the Fed keeps thinking out loud. That’s very intentional.

The Market is dealing with a lot of moving pieces. The Fed keeps talking, trying to get their words to do some of the work. It’s working. The talk is hawkish with more calls for a March liftoff and 4 total rate hikes this year. There has been significant repricing to account for this, which seems largely done. The 2-Year Treasury yield is bumping up at 1% already. That is the front end of the curve. We still aren’t convinced the Fed hikes 3 times this year, let alone 4. The 10-Year yield backed off the spiking highs of 1.8%. It’s trying to stabilize in the 1.7% range. The 10-Year Treasury is the benchmark. It’s the risk-free rate. Bonds are impacted by it. Mortgages are impacted by it. Stocks are impacted by it. It’s that important. I repeat my favorite Carville quote: “The Bond Market can intimidate anyone.”

Fed Chair Powell eased concerns on Tuesday of an overly hawkish Fed as it unwinds its emergency policies. He cited the ongoing challenges of Covid and the discipline of studying the data before making any bold moves. The Market certainly responded favorably. Growth stocks got a reprieve from their battering, and lit up for a couple of strong sessions. The whipsaw price action is likely to continue until there’s more certainty. The problem is, we’re going to have to wait for more certainty.

The Omicron variant is sweeping across the country. Infection numbers continue to surge. Hospitals are strained due to a shortage of healthcare workers. Living with Covid is a tremendous challenge. It puts so much stress on the system. New Jersey reinstated a public health emergency due to the situation. Chicago closed schools. California has even ordered Covid-positive medical staff that are asymptomatic to stay on the job. Hospitalizations are higher than last winter’s peak. That was before the mass distribution of vaccines. But there are real signs that cases have peaked in South Africa and the United Kingdom. That suggests a possible peak in the US by the end of January. The Market seems to be sniffing that out. That sets up for an economic boom in the Spring, with people getting out and about. Despite the challenges of the now, what’s coming next looks more promising for economic activity.

There was a slowdown at the store; Both at the malls and online. December retail sales fell nearly 2%. They were expected to be flat. November was revised down to a mere 0.2% monthly rise. This was the worst monthly retail report in a year. There were big monthly drops at online retailers, which were down 8.7%. Department stores saw a 7% decline in sales. Furniture fell 5.5%. Sporting Goods and Apparel were down 4% and 3%. Keep in mind, they were still 17% higher than the December prior. Perhaps more important, a major theme for the Holiday Season was the pull-forward of shopping. Consumers were told to “buy it while you can” in the Fall due to concerns about product availability due to the supply chain disruptions. Americans opened their wallets for the Holidays. They just bought early, and they bought often. Demand is not the issue in this Economy. Demand is still strong.

Earnings Season has begun. The Big Banks always lead things off. Financials and Energy have been the areas of strength in 2022, while Tech has been hammered. Earnings Season began with a thud. Expectations are high. JP Morgan and Citi didn’t deliver. We trimmed our Financial holdings earlier this week ahead of the print, feeling a lot was already priced in. The Market keeps rotating with increasing frequency. We have re-positioned to account for what looks like a turbulent ride for the first half of 2022. We’re already experiencing it. We have moved up the Quality Curve, shifting away from Growth as the Fed liquidity unwinds. Interest rates are the price of money. It’s getting more expensive to borrow. Bonds keep selling off because higher yields mean lower prices. That’s standard stuff. The good news is there are no signs of real stress in the credit markets. We don’t see any systemic problems. High Yield Bonds are behaving just fine. What’s going on is a recalibration of asset prices as the price of money moves higher. We expect this to continue for a bit and will continue to navigate with a little more defensive positioning in place. Living with Covid continues to be quite complicated.

Have a nice weekend. The Market will be closed on Monday, in honor of Dr. King’s birthday. We’ll be back, dark and early on Tuesday.


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