By Ben Norris, CFA, Securities Research Analyst, Associate Vice President
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Two weeks ago, I wondered whether the emerging omicron variant would have any effect on the Federal Reserve’s monetary policy plans. Similarly, investors have spent the last few months wondering whether the Federal Open Market Committee (FOMC) would make the rumors come true and accelerate the tapering of stimulative bond purchases. We got answers last week as Chairman Jerome Powell and the rest of the FOMC accelerated the pace of tapering to now conclude sometime in spring 2022 (the expectation was summer 2022 prior). In addition to the accelerated tapering, the FOMC essentially confirmed that they will begin to raise target interest rates next year and plan to hike rates roughly eight times over the next three years. This relatively aggressive stance is drastically different than the committee’s posture at their September meeting where half of policymakers wanted to wait until 2023 to begin raising rates. A reasonable question to ask in a situation like this is: What happened?
Stubborn inflation and strong employment figures happened. Inflation has persisted longer and at a higher level than the Fed initially thought likely. Last week’s Producer Price Index (PPI), an inflation metric that directly reads to CPI, came in much higher than the forecast number and reinforced the notion that higher inflation is here to stay. Chairman Powell even acknowledged that the much- touted “transitory” nature of inflation was likely no longer relevant as inflationary pressures have remained constant in 2021 and will no doubt continue in 2022. While inflation remains a headwind for the Fed, strong jobs numbers have also served as a pressure point. The unemployment rate fell to 4.2% two weeks ago, nearing the Fed’s target level of full employment. At the same time, initial and continuing jobless claims continue to trend toward pandemic-era lows while the number of job openings in the U.S. is at a record high. Combine high inflation and strong employment figures (which have the potential to make inflation worse) and the Fed is left with no choice but to end the easy money party or risk overheating the economy, omicron variant or not.
While the market mostly took the tapering and rate hike news in stride, surging COVID-19 cases have renewed investor concern. The major indices were down last week following strong selling pressure on Thursday and Friday as reports indicate that the omicron variant of the virus likely spreads more easily than other variants and current vaccines might not provide the same level of protection as they have in the past. The S&P 500 Index (SPX) was down 1.9% on the week but is still up a strong 24.7% year-to-date. The tech-heavy Nasdaq Composite (COMP) was down 3% for the week but remains nearly 18% higher in 2021. Small-cap stocks fared better last week, bucking their recent trend, with the Russell 2000 Index (RUT) finishing 1.7% lower but gaining 1% in an otherwise weak Friday session. The Russell 2000 is up 11.1% for the year.
From a style perspective, value outperformed growth last week as investors anticipate higher rates weighing on the prospects for growth-oriented companies. As a result, traditionally defensive equity sectors outperformed. The Consumer Staples, Utilities, Health Care, and Real Estate sectors were the only positive performers for the week. In contrast, Technology, Energy, and Consumer Discretionary stocks were the biggest losers for the week despite their otherwise strong performance so far in 2021. Bond yields moved lower late last week even as rate hikes loom. The 10-year Treasury yield ended the week around 1.40%.
In economic news, President Biden’s “Build Back Better” plan was effectively killed over the weekend after West Virginia Sen. Joe Manchin indicated he would not support the bill following months of negotiations with the White House and fellow Democrats. Without support from all 50 Democratic senators, the bill has essentially no chance of becoming law in its current form. The plan was expected to be the next major stock market catalyst if passed because it would spur domestic investment and likely lead to higher earnings for stocks in economically sensitive sectors. The odds of any new major spending packages passing seem slim right now, but Democrats may go back to the drawing board in hopes of salvaging a smaller package in 2022.
Looking through the end of the year and into January, investors are becoming anxious for a “Santa Claus Rally” in which stocks traditionally move higher following the Christmas holiday and into the first few sessions of the new year. Since 1950, the S&P 500 has gained an average of 1.3% during this period and over the last 30 years the market has gained roughly 2/3 of the time. While history has investors hoping for gains to ring in the new year, recent market action may make things difficult with fewer and fewer stocks participating in the current market rally. Renewed strength in smaller stocks, like we saw in Friday’s session, would certainly help bring Santa Claus to town.
The upcoming week is shortened due to the Christmas holiday with markets closing on Friday. Short week aside, economic announcements have a busy week with Thursday as the focal point.
| Date | Report | Previous | Consensus |
| Monday 12/20/2021 | Leading Economic Indicators | 0.9% | 0.9% |
| Tuesday 12/21/2021 | Current Account Deficit | -$190.3B | -$205.5B |
| Wednesday 12/22/2021 | Q3 Gross Domestic Product (revision, SAAR) | 2.1% | 2.1% |
| Consumer Confidence Index (December) | 109.5 | 111.0 | |
| Existing Home Sales (December, SAAR) | 6.34M | 6.50M | |
| Thursday 12/23/2021 | Initial Jobless Claims | 206,000 | 206,000 |
| Continuing Jobless Claims | 1.85M | – | |
| Core Inflation (y/y) | 4.1% | 4.5% | |
| Nominal Consumer Spending | 1.3% | 0.6% | |
| New Home Sales (SAAR) | 745,000 | 766,000 | |
| U of Michigan Consumer Sentiment Index | 70.4 | 70.4 | |
| Friday 12/24/2021 | Christmas Holiday, None Scheduled | – | – |
Links to previously published commentaries can be found at benjaminfedwards.com/For Our Clients/Educational Resources/Market.