Fear and Greed

Question:  What is causing all the market volatility that started at the end of November? 

Answer: The days after Thanksgiving brought a pullback driven by two factors; an increase in COVID concerns and talk of the Federal Reserve (Fed) potentially tightening monetary policy faster than previously expected. 

COVID: New Cases and New Variants

Markets became concerned with headlines surrounding COVID at the end of November. Prior to this, investors were starting to look past COVID focusing on a return to more normal lives. At the start of 2021 COVID was a major concern but had fallen to sixth place of “worry factors” by the end of September. News of rising cases, shutdowns and new variants resurrected concerns. In the US, we’ve remained resilient as shown by strong employment, spending, and mobility data as reported by FactSet on November 30, 2021.

The World Health Organization (WHO) labeled the Omicron variant a “concern” placing it on many people’s radar. The transmissibility, severity, and evasiveness of Omicron against our current toolbox of vaccines and therapeutics remains uncertain with medical experts expressing varying opinions. The best-case scenario is that the variant doesn’t go mainstream (best outcome) and that symptoms are mild. We’ll continue to monitor its progress and would avoid making hasty or reactionary portfolio changes based on these headlines until there is more evidence to provide clarity. 

Fed Policy: Taper Tantrum

Fed Chair Powell testified in front of the Senate Banking Committee acknowledging the possibility of discussing the Fed accelerating the pace of reducing its bond purchases (currently at a $15 billion/month rate and expected to end by June) at the December FOMC meeting. It’s important to note that this is not the same as increasing interest rates.

Quantitative easing (QE) is what he’s talking about and that is bond buying by the Fed to increase confidence, narrow credit spreads, raise asset prices and reduce market volatility. It’s appropriate to slow QE because the goals of QE were successfully achieved months ago. With the government issuing less debt, the need for the Fed to buy Treasury securities to keep interest rates low is no longer necessary. Thus, it is prudent for the Fed to put this tool back in the toolbox and save it for the next ‘emergency’.

It’s likely that the Fed will be patient and reasonable when raising interest rates. The Fed would raise interest rates in response to economic growth which is powered by the consumer. Faster growth is a good thing for earnings and equities. The flip side is that it may fuel inflation which is the wildcard that could cause the Fed to raise rates more aggressively.

The ‘inflation story’ could turn into a ‘disinflation story’ by this time next year. Some of the factors that support this view are supply chains and oil prices:

• Supply Chains – There are signs of easing supply chain constraints. Container congestion at the port of Los Angeles and Long Beach are declining by approximately 40%. Car manufacturers report that the chip shortage is starting to normalize, and retailers such as Walmart and Target report that shelves are stocked for the holiday season.

• Price Relief – After rising to the highest level in seven years, crude oil is presently down over 25%. This should provide relief at the gas pump, as the national average gas price remains above $3.50 per gallon. The decline in prices applies to oil, iron ore, lumber, natural gas, soybeans, corn, and steel as well with these declining more than 20% from recent highs.

Bottom Line

Market volatility increased recently in response to the Omicron variant and Fed statements. Markets tend to experience at least three pullbacks of 5% each year. If we get to 5% this time, it would be the second pullback of this magnitude this year. The timing is a bit surprising as year-end is typically the strongest time of year for the equity market, but seasonality is not the best long-term indicator of performance.

Overall, given the strength of the economy and earnings, it’s expected that equity prices will likely recover and move higher in 2022, although at a slower pace relative to 2020 and 2021. As a result, pullbacks could be seen as opportunities to invest in favored equity sectors. However, valuations at current levels don’t leave much of a buffer to absorb the realization of potential longer lasting risks from things like COVID or missteps by the Fed. Adherence to a disciplined investment strategy designed to match your needs and risk appetite can help steer through recent volatility. Stay focused and plan accordingly.

The opinions expressed are those of the writer as of December 5, 2021, but not necessarily those of Raymond James and Associates, and subject to change at any time. Past performance is no guarantee of future results. Material is provided for informational purposes. These views should not be construed as a recommendation for any specific sector or security. Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices. Stocks are subject to risk and fluctuate in value.

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