BY: FRANK HOSSE
Director of Investments – Argent Trust Company | 615.385.2720
A Month At-A-Glance
• Equity returns were negative in November after faltering late in the month.
• Investors grappled with the uncertainty around the Omicron variant.
• The key inflation figure for the Federal Reserve rose 4.1% in October.
• Amid continued higher inflation readings, Fed chair Jerome Powell signaled a faster end to stimulus than what was previously laid out.
Equity markets were largely positive up to Thanksgiving Day but finished the month negative thanks to a rout on the Friday after Thanksgiving. Ned Davis Research noted that it was the worst Friday after Thanksgiving on record for the S&P 500. New Covid-19 worries, especially the appearance of the Omicron variant, were part of it. But Fed Chairman Jerome Powell also did his bit to alarm investors, announcing at a Senate hearing that the word “transitory” was no longer appropriate when talking about the current inflation trend. And he added, for good measure, that if necessary, Fed asset purchases could be scaled back more quickly than previously communicated. The S&P 500 finished the month down 0.69%. U.S. small-cap stocks fared worse with a loss of 4.17%. Foreign equity markets were negative in November and lagged U.S. stocks. Developed international stocks fell 4.65%, while emerging-market stocks lost 4.08%.
In the bond markets, the 10-year Treasury yield decreased in November. The yield had been increasing modestly through Thanksgiving—going from 1.55% at the start of November to 1.67% on November 23. However, during the risk-off environment in late November, the 10-year Treasury fell 24 basis points to 1.43% at month-end. The yield curve flattened as the market continues to increase its expectation around Fed rate hikes in 2022. Despite concerns over higher inflation and a greater number of hikes next year, the core bond index eked out a gain of 0.30% in November.
Chair Powell’s testimony can certainly be considered noteworthy. The headline takeaway is that the Fed will reduce their asset purchase program at a pace faster than previously expected. He noted that “the risk of higher inflation has increased” and that it was time for this year’s most used word in the financial press—transitory—”to be retired.” The term transitory may end up being the only thing that was transitory in 2021.
The Fed’s mandate is to try to optimize for two different variables: stable prices and maximum employment. With core inflation now well above their 2% average inflation target and continuing to rise, the Fed could be in a tough bind in the coming quarters. With their limited tools, the Fed wants to ease inflation off its multi-decade high, but at the same time avoid a policy switch that might depress the labor market and the economy overall. There’s a potential conflict brewing between the two mandates if inflation continues to run hot and the labor market stalls.
The other market moving event during November was the emergence of the omicron variant and its worldwide spread. It is still too early for anyone to know much about this variant, and it will likely be weeks until epidemiologists have educated opinions on it. Much like other variants, the key issues will be around (1) if it is more transmissible, (2) has a meaningfully higher fatality rate, and (3) if it’s able to evade current vaccines (as well as antibody treatments or immunity from prior infections). In the meantime, the market has to grapple with the uncertainty. It is certainly something to monitor—particularly government policy responses that could impact the global economy.
2022 looks to be another year of low yields and persistent monetary support, although at the margin, we believe this support will be decreasing. For fixed income, we are sticking to our short duration bias with a focus on higher yielding credit which should continue to offer modest returns.
Equity markets have been greatly aided by massive monetary and fiscal stimulus for many years. This will start to change in 2022. Financial markets will have to go through something of a reset – a multi-year, gradual reversal of ultra-loose monetary and fiscal policy. The Fed has so far communicated this very cautiously. Financial markets are already discounting a completion of tapering by mid-2022 and two interest rate hikes by December 2022.
When it comes to generating returns, we think there will continue to be no good alternative to equities. But that does not mean they are without risks. In our opinion, interest rates and inflation will remain key factors. Inflation is affecting equity returns in various ways. Most companies pass rising input costs on to customers and see the potential for higher revenues and profits. Therefore, we feel picking stocks with operational leverage and pricing power will be key in 2022. The impact of potentially more persistent inflation on PE multiples is less clear. Higher inflation expectations create the risk of volatile and rising interest rates which could result in PE compression for long-duration stocks.
Certain material in this work is proprietary to and copyrighted by Litman Gregory Analytics and is used by Argent Financial Group with permission. Reproduction or distribution of this material is prohibited, and all rights are reserved. Argent Financial Group is the parent company of Argent Trust, Heritage Trust and AmeriTrust.