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Daily Capital

Markets: It’s Beginning to Look a Lot Like Last March

Capital Markets Perspective brings you what to watch in the markets this week, published in partnership with Great-West Investments.

Week in Review

December 13– 19

♪♬  It’s beginning to look a lot like  Chr<skreeaaatchhhhh…>  last March?!

It seems like forever ago, but you might remember that one of the earliest and most tangible signs that this whole “COVID” thing was for real was when the NBA suspended its 2020 season in mid-March of that year. School closures, market volatility and travel restrictions were one thing, but when one of the world’s biggest and most profitable sports leagues decided that things were bad enough to temporarily shut down (they eventually moved the season to the now-famous “NBA Bubble,”) we all knew something truly unprecedented was going on.

Well, it’s happening again. As of Sunday, the NBA had postponed at least seven games,[1] joining the NFL and NHL in altering its schedule to sidestep outbreaks among its players. Travel bans are going back up, Broadway productions are shutting down and employers are backtracking on plans to bring employees back into the office, all because the new and improved variant, nicknamed Omicron by authorities in charge of naming scary things like hurricanes, winter storms and viruses, is spreading holiday fear faster than Santa and his reindeer spread Christmas cheer.

I don’t want to make too much light of the situation, because Omicron is a real (and scary) thing and is already extracting a heavy human toll, just as its predecessor Delta has done since it became the dominant form of the disease earlier this year. It almost goes without saying, but we would all be wise to take it seriously and do whatever we can to protect ourselves and our families, not least because the severity of symptoms generated by Omicron is still very much unknown.

But to me, it’s notable that markets have so far taken Omicron somewhat in stride, at least compared to the last time COVID had its way with our professional athletes. Omicron-related fear undoubtedly played a role in last week’s moderate equity market declines and corresponding “safe asset” rally, but you might recall that the NBA’s suspension announcement last March was accompanied by a 4.9% decline in the S&P 500 Index on the day it was announced – and that was on the heels of a 7.6% decline only two days before. That makes last week’s volatility look tame by comparison.

Maybe markets are voicing confidence that the social- and economic impacts of an Omicron-inspired surge in cases won’t be as severe or as long-lasting as the those that accompanied the arrival of the original virus; or maybe it’s just another example of how we’re learning to live with a disease that seems destined to become endemic the same way that common colds and seasonal influenza already are. Either way, it’s interesting to me that markets are paying attention to Omicron-COIVD, but aren’t anywhere near the state of panic they were in the first time around.

And that’s probably a good thing, because unlike the beginning of the pandemic, there are very real questions about how much further monetary and fiscal policy can stretch to accommodate a new round of COVID stimulus should it become necessary. In a way, a clearly hawkish move by the Federal Reserve after last week’s FOMC meeting is a case-in-point: On Wednesday, newly re-appointed Fed Chair Jerome Powell did what just about everybody expected him to do when he doubled the pace of the “taper” in an attempt to head off the chances that inflation would begin to run roughshod over the economy[2].

That announcement cut in half the time it will take the Fed to end so-called quantitative easing (which, if it continues at the same pace, is now “scheduled” for March, 2022 instead of mid-June,) and probably also pushes forward the timeline for lifting rates off the zero floor. (In fact, there’s a strong case to be made that the Fed’s new tone probably had a lot more to do with last week’s decline in stocks than Omicron did.)

Of course, Powell and his pals would do whatever it took to deal with Omicron outbreak should it become severe, and last week’s statement and press conference once again made it clear that the Fed is watching closely for exactly that outcome. But the stunning speed with which the Fed has changed its rhetoric – recall that it was only November when the Fed first announced it would scale back its bond purchasing activity, and it wasn’t too many months ago when the base-case for rates was zero through at least the balance of 2022 – serves as a case-in-point that many corners of the US’ political economy, people are rapidly becoming wary of stimulus as permanent policy.

The ferocity of the ongoing debate around President’s Joe Biden’s big infrastructure and social spending bill is another.

The sheer size of Joe’s Big Bill guaranteed that it would generate controversy and opposition from the opposite side of the aisle, but the fact that it’s fate has been sealed – at least temporarily – by one or two members of his own caucus speaks to exactly how thin patience has worn when it comes to stimulus-as-solution-to-every-ill.

Naturally one of the reasons that people from all political stripes are becoming less enamored of things like QE and massive fiscal spending programs is the perception that it has already begun to generate caustic inflation. After literally decades of calm, inflation has come roaring back in eye-popping fashion, confirmed once again by last week’s producer price index data which was just as elevated as consumer prices (“CPI”) that were released during the prior week. Indeed, prices at the producer level surged even faster than economists’ already, uh, inflated expectations, rising 9.6% year-over-year.[3] While so-called “core inflation,” (which excludes volatile prices for things like food and gasoline,) wasn’t quite as high, almost nobody would find comfort in that caveat since we still have to buy all that stuff anyway, whether or not economists choose to ignore it.

Sincere and well-meaning people can (and do) disagree about whether extremely loose monetary and fiscal policy is solely responsible for the recent spike in inflation, but most would probably agree that it definitely hasn’t helped. But another, perhaps even more worthwhile debate currently taking place is how long this surge in inflation might be with us. While the Fed famously dropped “transitory” from its inflation-related lexicon in recent weeks, Fed policy – and the market’s reaction to it – would likely be quite different if inflation is deemed to have become “entrenched” rather than something less permanent in nature.

As frequent readers of this update will know, there have been some signs that the inflationary psychology necessary for that to happen might be starting to creep its way into consumer surveys and the like, and that’s troubling. On the other hand, last week’s economic data was also somewhat reassuring – including this statement from Markit Economics’ preliminary look at its widely-followed Purchasing Manager’s Index for December, where they highlighted  a “marked easing in supply chain delays, which also helped take pressure off raw materials prices[4].” That sentiment was echoed in the Eurozone’s version of the same report[5], as well as both regional Fed manufacturing reports issued last week (Empire State[6] and the Philly Fed.[7]) Viewed collectively, that sentiment represents the best news on the inflation front that we’ve had in a very long time. Could it be that prices paid by producers – where the current spate of inflation showed up first and most robustly – is finally starting to ease?

If so, markets would probably be pleased. But on the other hand, cooling inflation is sometimes a sign that the economy in a broader sense is also cooling. To be clear, that’s not necessarily a bad thing in this environment, where demand for goods (and, to perhaps lesser extent services,) is outstripping the economy’s ability to supply them. But you have to take the bad news with the good, and one thing that might have been easy to miss in some of those same reports is a convergence between “current” and “expected” economic conditions. When those two lines cross over one another, bad things sometimes tend to happen to economic growth.

So where does that leave us? Well, I guess in sort of a good news/bad news no-man’s land: on one hand, a cooling off of demand and prices would definitely represent welcome relief from inflation-related commentary that has grown nothing if not relentless. On the other hand, too much cooling could place market- and consumer sentiment in jeopardy as investors and consumers begin to gird for an eventual economic slowdown. (Come back, Goldilocks – we need you!)

And in the background to all this is a general public (and a political class) that is becoming increasingly suspicious of generous stimulus to combat COVID at exactly the time when Omicron could make it once again a necessary evil. Add to that market valuations that are still somewhat elevated, and you have a set-up for 2022 that can only be described as wait-and-see.

What to Watch This Week

December 20– 27  

Notable economic events (December 20-24)

Monday: Leading economic indicators

Tuesday: No economic releases planned

Wednesday: Consumer confidence, CFNAI, existing home sales

Thursday: Income and outlays, weekly jobless claims, UofM consumer sentiment, new home sales

Friday: Markets closed

It promises to be a fairly light week, with many markets worldwide closed on Friday for observance of the Christmas/Christmas Eve holiday. That doesn’t necessarily mean there will be an absence of news, however, as Omicron, inflation, politics, and everything else that has been driving the narrative recently are unlikely to simply take a break and go skiing for a week like the rest of us.

In fact, what little news we do get this week could be amplified by seasonal factors that happen every year: trading volumes over the last two weeks of December tend to be light as many investors take time off to be with family. That can sometimes cause the news events that do occur to have out-sized impact (as seems to be the case on Monday morning as I write this commentary…)

In terms of what to watch, this week’s pair of consumer confidence releases (from the Conference Board on Wednesday and the University of Michigan on Thursday,) could be the most interesting bits of scheduled data we get this week. As mentioned above, consumers have obviously noticed the impact inflation is having on their finances and are beginning to change their buying behavior in response. A small and controlled dip in confidence and/or spending wouldn’t necessarily be a bad thing, but if there is instead any evidence that consumers are aggressively pushing planned purchases forward to avoid paying even higher prices in the future, markets might interpret that as a sign that an inflationary spiral is developing. That might in turn overwhelm last week’s marginally good news about inflation and could set the stage for another spike in volatility.

But however interesting consumer confidence data may be, its ultimately just what people say, not what they actually do. As a cross-check, it’s often wise to also pay attention to where and how much consumers are actually earning and spending their cash. The Bureau of Labor Statistics will oblige that need on Thursday when it releases its monthly income and outlays report. That view into where Americans earn their money (and how they spend it) is perhaps even more important than usual this time around given a mild disappointment in retail sales this week[8]. Some economists were hoping for a post-COVID splurge in holiday spending by US consumers, but that has yet to show up in spending data.

Finally, barring something truly exceptional, this will be the final Weekly Perspective before the Christmas holiday. Whatever your tradition, I hope the season brings you peace and harmony and hope for a joyous new year.

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Personal Capital Advisors Corporation (“PCAC”) is a wholly owned subsidiary of Personal Capital Corporation (“PCC”), an Empower company. PCC and Empower Holdings, LLC are wholly owned subsidiaries of Great-West Lifeco Inc. Source for index data: Bloomberg.com; GWI calculations.

 

[1] https://theathletic.com/live-blogs/

[2] https://www.federalreserve.gov/newsevents/pressreleases/monetary20211215a.htm

[3] https://www.bls.gov/news.release/pdf/ppi.pdf

[4] https://www.markiteconomics.com/Public/Home/PressRelease/f63974aa5288481688b386caf47905e1

[5] https://www.markiteconomics.com/Public/Home/PressRelease/447e0d3d0ffd431088329eea66ebcb5a

[6] https://www.newyorkfed.org/survey/empire/empiresurvey_overview

[7] https://www.philadelphiafed.org/surveys-and-data/regional-economic-analysis/mbos-2021-12

[8] https://www.census.gov/retail/marts/www/marts_current.pdf

Thomas Nun, CFA, is a portfolio strategist for Great-West Investments.
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