The stock market isn’t exactly off to a rip-roaring start to 2022, what with the Nasdaq 100 suffering its worst start to the year since 2000 and all, but there are reasons for optimism.
Basically, Omicron has done what the Fed failed to do, and there are signs that that the worst of inflation is now behind us. Here are some reasons for hope from the past week (along with a couple of reasons to remain concerned):
· Purchasing Managers’ Indices
The Institute for Supply Management’s gauges of supplier deliveries and of prices paid for materials both fell in December to their lowest levels in more than a year.
· Food and Energy Prices
The cost of wheat is down 14% since Thanksgiving. Beef prices are off their summertime highs by more than 10%. And-- praise be to God— coffee prices are down 9% in the last month. After surging the most in a decade last year, a United Nations Index tracking everything from grains to meat slid 0.9% in December, hopefully helping to ease last year’s run-up in grocery prices.
· Supply Chains
A new gauge of global supply chain disruptions developed by the Federal Reserve Bank of New York showed that while pressures are at the highest level since at least 1997, there are signs of a peak and strains “might start to moderate somewhat going forward.”
· Borrowing Costs
The Federal Reserve indicated last week that it will tighten monetary policy faster than in recent history in order to tackle inflation. The Fed minutes released last week stated, “…the current economic outlook was much stronger, with higher inflation and a tighter labor market than at the beginning of the previous normalization episode…” and “that the Federal Reserve's balance sheet was much larger, both in dollar terms and relative to nominal gross domestic product (GDP), than it was at the end of the third large-scale asset purchase program in late 2014.” (As a percentage of GDP? Wow, is that an understatement!) It sounded like a classic mea culpa, acknowledging that they’re behind the curve in dealing with inflation and intend to make up for lost time.
Bond yields pushed higher with those on two-year U.S. Treasuries locking in the biggest weekly spike since October 2019. In other words, just like Omicron, traders are doing some of the central bankers’ work for them.
· Credit Card Debt
Here at RG, we’re always looking to muffle the static of the markets, to zero in on the stuff that really matters and to tune out the rest. The November consumer credit report from the Federal Reserve released last week really mattered.
Consumer credit exploded by a whopping $40 billion in November, twice the expected $20 billion print, more than double the $16 billion October number, and the highest on record.
Revolving debt—that’s credit card debt-- more than tripled in November, soaring to $19.8 billion from $6.6 billion in October, by far the highest such print ever.
The report makes it pretty clear that any excess savings accumulated by the US middle class are long gone, and Americans have unleashed a credit-card fueled spending spree in their place. Thank goodness Robinhood won’t accept deposits on a Diner’s Club card.
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That’s the data, but I think an optimistic rationale can be explained by something less tangible. It comes from the camp of those who believe the Fed can learn from its previous mistakes. …These people must clearly be categorized as “eternal optimists,” but let’s consider.
Back in 2018, we had two separate major stock market corrections, culminating with a horrific 20% crash going into Christmas that finally forced the Fed to reverse course. The Fed had run off its balance sheet, meaning that it had let bonds mature without replacing them with new bonds, since March. The Fed Funds rate had gotten up to 2.5%, the yield curve inverted about a half a year later, and 2020 was shaping up to be a recession with or without Covid.
Putting the Fed balance sheet into run-off while simultaneously hiking rates was a bad idea in that environment, and the Fed had the belated good sense to dismantle the hiking cycle just a few months later, which is why you would not be alone if you got spooked by the Fed minutes last week where a few members (unclear how many) discussed the possibility of run-off. However, after this last month of economic activity, I’m far from convinced that all the members of the Fed are on board.
The reality is that these bond buying programs should have been slowed this past summer as home prices, the stock market and retail sales were exploding to the upside. We were screaming about this very thing back in May! So, yes, the sooner they stop stimulating the market, the better-- they are late-- but they’re not looking to go so fast as to repeat the mistakes of 2018. That’s the bullish argument here.
We spent the last quarter strategizing for a Fed that would have to hike much faster than in previous cycles, which would indeed make for a difficult investing environment that remains as the one we still consider most likely, but bulls might take heart in the effects of Omicron on economic activity, bond traders’ recent pricing-in of higher rates, and even the possibility that the Fed will step back from this idea that they need to continue to tighten right into the teeth of an economy that’s already showing cracks in the armor.
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There are so many stocks down more than 10% over the last couple of weeks; there are probably some bargains to be found, although I’m not one for trying to catch a falling knife. I expect we’re starting to sound a little like a broken record with our refrain to focus on energy and financials, but they once again outperformed last week while tech and healthcare lagged significantly:
Source: Fidelity Investments
Healthcare and biotech have been destroyed over the last six months, especially within the genomics space. If inflation moderates and rate hikes therefore become less likely, high growth areas like that will start to look pretty ripe. Time will tell.
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