Hi friends, welcome to our December 2021 market outlook, and our last outlook of the year! Next time we write to you will be in 2022, and at this point, the uncertainty is very high….around the economy, inflation, markets, COVID variants, etc. We have a lot to cover, so let’s jump right in.
After the rout that occurred in the stock market since mid-November, everyone is hoping for a Santa Claus rally. Let’s hope he really spreads joy this year, especially in the growthier names. That’s in reference to the pivot from growth to value, which has been playing out since early November. The funny part, or not so funny part, is the market always tries to throw off its rider, similar to a bull, hence the name bull market. Earlier in the year, after most predicted value finally catching up to growth, growth caught a strong bid and value got thrown to the curb. Some of that was related to interest rates, but mostly due to Covid, and the “recovery stocks.” After trailing benchmarks to start the quarter, most investors were forced to add back growth. Well, the market once more played the masses as it quickly pivoted back to value in the last month. That said, going forward, and looking at 2022, we believe portfolios need to have a higher allocation to value over growth. Our thesis is simple- inflation is persisting and will continue to be a problem in 2022. The tapering of asset purchases by the Federal Reserve has started but they have already laid out for ending the entire program. The Fed continued with their pivot 2 weeks ago and didn’t walk back a rate increase in June of 2022, if not sooner. In a rising rate environment, growth suffers. That makes a lot of sense, especially when you look at what stocks benefitted from ultra-low- interest rates from the last 10 years- growth. In an environment where inflation persists what benefits or appreciates? Small cap stocks by a great degree, value over growth, real assets (real estate, timber, lumber) over paper assets, commodities (gold, oil, copper). With rising interest rates, long duration bonds suffer. If our thesis plays out correctly, and we do get that Santa Claus rally, that will be the best opportunity for investors to pull some chips off the growth train- which is essentially every portfolio we’ve seen as a result of the outperformance over the last decade. Please pay heed and move forward with caution. Last but not least, those who play close attention to the bond markets, have realized the yield curve has been flattening, meaning short-term rates have risen while longer-term rates have fallen. A flattening yield curve is typically a sign that growth is slowing or that a recession is on the horizon. We’re not in line with the latter. But for more color, here’s what Peter Boockvar, Chief investment officer of the Bleakley Advisory Group, wrote: “I’ve kept making the case that the reason why the yield curve is flattening is because of the market pricing in Fed tightening as the QE taper is now upon us (however the speed). This is because there is no such thing anymore as a ‘soft landing’ when the Fed tries to normalize policy because the economy and markets are so dependent on Fed policy and intertwined, it’s impossible to separate them out unfortunately. As I’ve also said before, we no longer have regular economic cycles and instead have credit cycles that ebb and flow with the cost of capital driven by Fed policy.”
Since the last time we spoke, and in case you’ve been living under a rock, or took “cord-cutting” to the extreme, a new variant has emerged in the war against Covid, Omicron. Being Greek, I feel bad for the rest of you who involuntarily signed up to learn the Greek alphabet. Joking aside, and based off the limited data we’ve received, there could be a positive side to this story for society and markets. Those of you who have studied past epidemics or pandemics, similar to the Spanish flu, realize this is the natural course for these variants. Throughout human history, and way before vaccines existed, pandemics and epidemics transitioned to the flu, or what we’ve come to know as the common cold, which is a SARS covid variant in of itself. The beneficial data I’m referring to is the much milder symptoms this variant is passing along. As more countries report cases of the omicron Covid-19 variant, there is some good news from South Africa where the strain was first identified. Initial data from major hospitals in the country shows that patients need less medical intervention, pointing to a milder infection than that caused by the delta variant. There could a silver lining in here, and hopefully signals the end of Covid-19, at least how we’ve known it over the last two years.
Last but not least, we have to mention inflation, something I’m sure everyone is feeling, but sick of hearing. It’s not going away. In fact, it’s getting worse. And if you used the 1980 version of calculating inflation- it’s closer to 10%, not the 6% that’s being reported. That’s due to housing being removed from CPI which was replaced with OER- owners’ equivalent rent. Well, housing prices are up 20% year to date. Rents are now starting to increase at a startling rate and we’ll soon see how this affects the numbers. We get the next CPI report tomorrow.
The interesting thing I’d like to point out, normalizing Fed policy has never been easy. Every time we go to normalize policy, whether it be tapering asset purchases or raising rates, the market has a tantrum, Fed reverses policy and, hence the term, Fed Put. We saw this in 2018-2019. Markets sold off hard at the end of 2018, after Chair Powell infamously talked about the Fed going beyond neutral. And then there were rate cuts in 2019. Some see echoes of 2018-2019 today, but there’s one obvious difference. Inflation is over 6% now. At that time, the Fed was still struggling to hit its 2% target on a regular basis. As such, the bar towards something more dovish may be way higher right now and tricky to navigate. In other words, there might be a point, where the Fed looks at volatility and thinks “ok, might be time to pivot towards something more dovish” but we need a lot more evidence to get there when inflation is still running this hot. It’s worth thinking about the key point that in a period of elevated inflation, the type of Fed agility that provides support to the market during periods of stress may not be there.
That’s it. We’d like to wish everyone a happy holiday season and a happy new year! Here’s to hoping for more clarity in 2022! All the best, and as always, please reach out with any questions or concerns.
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