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Monthly Market Update - December 2021

December 02, 2021

While COVID concerns loom with the new Omicron variant, the economy remains very robust as we head into December. The main concern now is the priciness of the market relative to present risks. Here are our thoughts.

The Omnipresent Omicron?

Covid will just not go away. That was supposed to be ok with vaccines and viral therapies to help prevent serious illness in those who are exposed. Now the holidays are here, but so is this highly mutated variant that is reportedly alarming doctors and policy makers across the globe. The concerns include the potential for reduced vax efficacy and higher transmissibility. This obviously has serious implications, not just for our investment portfolios, but our physical and economic health. Observed symptoms are reportedly “mild” but there is much that is still unknown, and this is an extremely fluid situation.

Omicron has now been detected in dozens of countries, including the US. It’s a game of wait and see, and the markets hate uncertainty more than anything. The more variables that can affect future cash flows and earnings, the wider the ranges can be for investment outcomes and therefore, higher risk premiums. Volatility will be the watchword over the next several days to weeks as scientists and doctors unpack the data. Each development has the potential to whipsaw markets.

The good news is the economy remains very robust.

The labor market is showing marked improvement with the latest reports displaying a consistent pace of added jobs, in manufacturing and other sectors necessary for sustained growth. November appears to be continuing that pace with a very welcome private-sector monthly jobs report from ADP adding another half a million-plus jobs. As more workers enter the job market, this will help ease inflation and supply chain pressures. We will keep a close eye on the December 3rd jobs report along with the central bank’s mid-December policy meeting.

Strong economic data will be paramount to support the current valuations, and thus intermediate choppiness, and maybe even a 10% or so correction would be healthy. The S&P 500 is off around 4-5% from its all-time high in late November. Throughout the month, money didn’t necessarily leave the market - it essentially moved back and forth between cyclicals/re-opening trades and “defensive” tech/stay home names. ESG exposure tends to be heavier in technology and growth, and as we’ve discussed, is much more of a secular long-term trend which should endure the near-term volatility.

The main concern now is the priciness of the market relative to present risks.

Total U.S. equity market capitalization is about 215% of U.S. GDP, which is the highest ever. Long-term earnings growth rates tend to be well correlated with growth in GDP. The stock market is certainly factoring in the strength of the economy plus increased productivity over the long run.

The bond market is not, with yields continuing to fall over the past week, despite inflationary pressures. The 10-Year yield had been on a tear, materially breaking above the 1.6% handle in mid-November, before dropping to below 1.5%. Fear of stagflation (low growth paired with high inflation) continues as investors pile into TIPS and other inflation protected asset classes. Oil moved close to 85 dollars a barrel following President Biden’s announcement that the US would release reserves from the Strategic Petroleum Reserve to relieve price pressures. Prices then dropped to below $70 per barrel on the variant news. So, the risk on/risk off continues with the variant news but having a long position in global equities continues to be just about the only game in town when accounting for inflation.

Market gyrations in November

Overall, November was relatively tame until the market gyrations began with news of the variant in a limited volume trading session after Thanksgiving. Then, newly re-nominated Fed Chair Jerome Powell spoke to the Senate Banking Committee and moved his rhetoric to a surprisingly more hawkish tone, with taper talks accelerating. Pressure is coming from congress and constituents to address inflation while wrangling in fiscal deficits and debt, both of which would mean less stimulus. In his testimony, Chairman Powell also mentioned that climate may have a potentially large effect on financial stability.

Sustained inflation

Investors and consumers’ patience proved to be the only thing that was “transitory” when it comes to inflation. The October report showed that CPI increased 0.9%, while core CPI (excluding energy and food) came in at 0.6%. Both figures were far higher than economists' consensus estimates. Powell reflected this in his comments, retiring the T word, acknowledging that stronger inflation has become more entrenched. The silver lining in this is that the Fed is aware that sustained inflation is not just from supply chain pressures, but the strength of the economy. While the Fed may be signaling less accommodation, which is probably overdue, it is not yet implementing restrictive policy ahead of schedule.

Downside risk management will be key, along with diversification internationally and utilizing bonds as a buffer, which can help soften the volatility of a domestic stock portfolio. We have reflected this in our models with healthy exposure to areas such as Europe and EM where valuations are relatively attractive for the long run, despite the potential for more shutdowns. Bonds don’t provide much for yield, but certain sectors can cushion to the downside in a flight to safety. We are staying consistent from an equity sector exposure standpoint as well.

The new variant is an added layer of complexity to an already complex market.

I have found that the murkier things are, with many unknowns in the short term and a lack of material structural changes – it is not advisable to make a knee-jerk investment decision. Strategic asset allocation is built for the long term for a reason: to see through the noise and volatility, and if anything, use it as a buying opportunity. We hear “buy the dip” quite a bit these days regarding any small price declines to domestic equities with Fed policy remaining staunchly accommodative. Some are questioning that as the risks to this market are becoming clearer.

For much of the year, investors yawned over negative news surrounding consumer confidence, supply chains, geopolitical risk, and higher inflation prints. Clearly the potential for lockdowns from variants and the removal of stimulus is enough to move markets. Investors are feeling like they need to become amateur virologists. Instead of that, let’s continue to rely on sound investment principles and stay the course, with diversification and risk mitigation in mind. It will help you sleep at night and maybe even allow you to enjoy the “most wonderful time of the year” that much more.

Happy Holidays!

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