December 2021 – Dan Zalipski, CFA®
The last several weeks have been volatile with a series of headlines moving the markets. The day after Thanksgiving, while many Americans were out shopping for the holidays, word of the new COVID variant Omicron was announced. Carrying more mutations and being more transmissible than the Delta variant, the Omicron variant was flagged as being able to potentially evade protection from the current lineup of COVID vaccines, sending the market lower while the world waited for more data. Fortunately, it appears that the current vaccines and antiviral medications will help reduce the worst-case scenarios, but an increase in break-thru infections is possible. Investors expect consumers will curb their behavior in the weeks ahead in response to Omicron. Restaurants are already beginning to see a decline in patrons, and numerous professional sporting events have already been postponed. Similar to the Delta wave, consumers will likely reduce their activity regardless of what the government suggests.
The latest inflation report confirmed what everyone expected, prices are still rising at a speed not seen in nearly 40-years. The Fed concedes inflation is running higher for longer than they expected, dropping the word ‘transitory’ from their comments. In response to the current conditions, the Fed has adjusted course, increasing the speed at which they wind down their bond buying program, the precursor to raising interest rates. Speaking of rates, the Fed was pointing to 2023 for lift-off as recently as September. Now they expect 3 rate hikes in 2022, with the first coming in either March or June.
While the stock market is digesting these new developments with some fresh volatility, the bond market is sending mixed messages. Conventional wisdom states that the threat of rising rates, especially sooner than later, should have upward pressure on yields, but we’ve seen just the opposite. Yields on treasuries have been on the decline, causing the yield curve to continue to flatten. A flattening yield curve that eventually inverts has a decent track record of predicting recessions. The timing from inversion to recession can be months to more than a year, while not an imminent threat, still worth keeping an eye on.
One other possibility for the move in yields could simply be year-end rebalancing by the large institutions. Due to the outperformance of equities relative to bonds through 2021, these large shops find themselves with too much stock and not enough bonds and will sell stock to rebalance into bonds. Unfortunately, that type of activity on the scale which these large institutions operate on may continue to put pressure on stocks through year-end. The window for a Santa Claus rally isn’t closed, but the clock is ticking.
We at Vantage would like to wish everyone a Merry Christmas and a Happy New Year.
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