Current Market Observations

by William Henderson, Vice President / Head of Investments The equity markets reacted negatively to the discovery of a new highly transmissible COVID-19 variant in South Africa. The announcement of a new strain, dubbed omicron by the World Health Organization, shocked markets and impacted most major sectors. The Dow Jones Industrial Average dropped by -2.7%, the S&P 500 Index fell by -2.3% and the NASDAQ dropped by -3.1%. However, all three major indexes remain in positive territory for the year. Year-to-date, the Dow Jones Industrial Average has returned +15.9%, the S&P 500 Index +23.9% and the NASDAQ +20.9%. The U.S. Treasury market reacted as expected to bad news, with prices rising on bonds, reminding investors why bonds remain an anchor in most portfolios – providing the needed risk management tool while risk assets are selling off. Last Friday, the 10-year U.S. Treasury briefly dipped below 1.50%, before settling in over the weekend at 1.53%, four basis points lower than last week and well below the 1.74% level reached in March of this year.

Last week, we talked about the VIX (CBOE Volatility Index – or measure of the market’s risk level) and how “calm” the VIX had been thus far in 2021. Well, add in an omicron variant, and the VIX spikes to a 10-month high. See the chart below from Bloomberg.

As of the writing of this article, the markets are already rebounding nicely, and many market prognosticators are calling it a “buying opportunity.” We often get that question: “Is this a buying opportunity?” Our answer is always the same: “YES!” If you are a long-term investor, with appropriate risk levels applied to your portfolio, every day is a buying opportunity as time generally smooths out peaks and valleys in the markets.

Certainly, this new COVID-19 variant puts the unknown element back into the markets, but we have seen this before with the delta variant and the pharmaceutical firms are already touting the need for another booster shot to deal with the omicron variant. Further, FED policy markets are well aware of the issue and resultant market and economic implications. This means that their announced monetary policy tightening, and bond purchase tapering could at any time be adjusted. In fact, trading markets are already pushing out their expectations of the first rate hike to July 2022 from June 2022.

Lastly, there seems to be an overall consensus gathering in Washington and Wall Street that the pandemic is becoming endemic and will be with us in some form or another for quite a long time. For each sector negatively impacted by lockdowns and new COVID strains such as travel & leisure, there are sectors that are positively impacted such as technology and bio-tech. There are a lot of economic indicators being released this week including data around retail sales, home prices and the labor markets. This information will give us needed information about the future of the economy, the direction of Fed policy and the sentiment and strength of the consumer. Inflation continues to be a concern and the question remains about which parts of inflation will be transitory vs. permanent.

Certainly, last week was a sell-off in all market sectors but we have talked about sell-offs occurring in every major bull market – so this is generally typical market behavior. However, over long periods of time, sell-offs are simply blended into long-term returns. See the chart below from JP Morgan showing performance of portfolios over time.

In any given single year, equities alone can produce a return of –39% and a blended portfolio of –15%. Looking out 20 years, both portfolios are in positive territory. Simply put – investing is a long-term activity.

The Numbers & “Heat Map”

THE NUMBERS
Sources: Index Returns: Morningstar Workstation. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. Three, five and ten year returns are annualized. Interest Rates: Federal Reserve, Mortgage Bankers Association.

MARKET HEAT MAP
The health of the economy is a key driver of long-term returns in the stock market. Below, we assess the key economic conditions that we believe are of particular importance to investors.

US ECONOMY

CONSUMER HEALTH

POSITIVE

U.S. GDP growth decelerated to a 2% annualized pace in Q3. The slowdown was driven primarily by supply chain constraints. Economists expect a modest acceleration in Q4.

CORPORATE EARNINGS

POSITIVE

With 95% of S&P 500 companies having reported Q3 results, sales and earnings are up 17.5% and 39%, respectively. However, company commentary suggests that the supply chain has been and will continue to be problematic in the coming quarters.

EMPLOYMENT

POSITIVE

The unemployment rate is down to 4.6%, as of October. The labor market is very tight at present as many employers, particularly in the Leisure and Logistics sectors, are struggling to fully staff because the labor participation rate remains below pre-COVID levels. The labor shortage is one of the causes of the global supply chain glut.

INFLATION

NEUTRAL

CPI rose 6.2% year-over-year in October, the highest increase since 1990, driven by the global supply chain backlog. Will inflation be transitory or permanent?

FISCAL POLICY

POSITIVE

A $1.2 trillion infrastructure bill was passed by Congress. A $1.75 trillion spending bill passed by Congress also went to Senate for revisions.

MONETARY POLICY

POSITIVE

The Fed will begin bond tapering by November’s end. By mid-2022, all Fed bond purchases will halt. The Fed’s bond buying program works to keep interest rates low. Inflation concerns are persisting, and some are calling for faster tapering and high rates.

GLOBAL CONSIDERATIONS

GEOPOLITICAL RISKS

NEUTRAL

A new COVID-19 variant, omicron, was discovered in South Africa and countries around the world immediately reacted by closing borders to foreigners. While still new and unknown, this needs to be closely watch for potential long-term impact globally and risks of new “lockdowns,” which could severely impact economic recoveries.

ECONOMIC RISKS

NEUTRAL

Supply chain disruptions are hampering the economy; however, demand remains very strong. While global logistics are operating far below normal efficacy, it appears the supply chain is slowly improving and may reach normalcy by mid-to-late-2022.

The “Heat Map” is a subjective analysis based upon metrics that VNFA’s investment committee believes are important to financial markets and the economy. The “Heat Map” is designed for informational purposes only and is not intended for use as a basis for investment decisions.

Quote of the Week

“Tomorrow is the most important thing in life. Comes in to us at midnight very clean. It’s perfect when it arrives and it puts itself in our hands, and hopes we’ve learned something from yesterday.” – John Wayne

“Your Financial Choices”

Tune in Wednesday, 6 PM for “Your Financial Choices” with Laurie Siebert on WDIY 88.1FM. Laurie will discuss: Considerations in Holiday Spending and Gifting.

Laurie can address questions on the air that are submitted either in advance or during the live show via yourfinancialchoices.com. Recordings of past shows are available to listen or download at both yourfinancialchoices.com and wdiy.org.

Current Market Observations

by William Henderson, Vice President / Head of Investments
Last week saw a mixed market as the S&P 500 and the NASDAQ posted slight gains, but the Dow Jones Industrial Average sold off as industrial sectors such as materials, energy, and financials showed weakness. For the week’s end, the Dow Jones Industrial Average fell -1.4%, while the S&P 500 Index increased by +0.3% and the NASDAQ jumped by +1.2%. Across all major market indexes, year-to-date returns remain solid, pointing to a potentially record setting 2021. Year-to-date, the Dow Jones Industrial Average has returned +18.3%, the S&P 500 Index +26.7%, and the NASDAQ +25.3%. The 10-year U.S Treasury moved higher by two basis points closing the week at 1.57%, modestly below 1.74% level reached in March of this year. Strong inflation pressures are hinting that the Fed’s tapering of bond purchases may accelerate, and higher short-term rates could be sooner than mid-2022 as economists had predicted. 

With the Thanksgiving holiday this week, the House narrowly passed President Biden’s $1.75 trillion social spending bill, sending it to the Senate. It is widely expected that the bill will languish in the Senate for several weeks where further revisions will take place. The only important news out of Washington this week was President Biden’s nomination for Federal Reserve Chair, Jerome Powell, to serve an additional term. The race for this critically important post had come down to either keeping Jay Powell for an additional term or nominating Fed Governor Lael Brainard as his replacement. As we have said often, uncertainty is the one thing the markets really fear so keeping Powell on board soothed the markets. Brainard was nominated as Vice Chair. 

While inflation is running hot, and COVID-19 cases are rising outside of the U.S., the markets do not seem concerned. Look at the chart below from the Federal Bank of St. Louis showing the CBOE Volatility Index or VIX. The VIX measures the market expectation of near-term volatility conveyed by stock index option prices; essentially a quantitative way to measure risk, fear, and stress in the markets. The VIX is currently trading well below the “panic” levels seen at the beginning of the pandemic and arguably near its average trading level since 1990.   

The efficient market is seeing heightened capital expenditures by corporations, positive earnings strength, healthy bank balance sheets and a consumer poised to accelerate spending, hence a very low VIX reading. The markets are quiet but are they too quiet? Remember, pull-backs happen in every bull market, and we believe pullbacks are healthy for functioning markets. See the chart below from Clearnomics and Valley National Financial Advisors showing the performance of the stock market each year (bars) and the largest intra-year decline (dots) each year. The average drop in any year is -13.5% but the long-term average of the market is +9.0% each year, regardless of the pullbacks.  

Markets are efficient and volatility is a normal part of investing. The smart investor is rewarded for staying disciplined and remaining invested, especially during times of short-term market volatility. 

In the United States, the CDC announced that anyone over age 18 can receive a COVID-19 booster shot. This good news comes on the heels of rising Covid-19 cases in parts of Europe. Austria, for example, initiated a national lockdown and Germany said it may consider the same as new cases continued to surge. Certainly, rising COVID-19 cases anywhere, but specifically in the EU or U.S., will weigh heavily on the financial markets and will need to be monitored closely. This week is a shortened holiday week with the markets closed for Thanksgiving on Thursday and an early close on Friday. Watch for Wednesday’s economic releases including 3Q GDP, U.S. Federal Reserve Meeting Minutes, and weekly unemployment claims – all which could give signals to market movements through year-end and into 2022. 

Have a warm and family-filled Happy Thanksgiving.  

The Numbers & “Heat Map”

THE NUMBERS
Sources: Index Returns: Morningstar Workstation. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. Three, five and ten year returns are annualized. Interest Rates: Federal Reserve, Mortgage Bankers Association.

MARKET HEAT MAP
The health of the economy is a key driver of long-term returns in the stock market. Below, we assess the key economic conditions that we believe are of particular importance to investors.

US ECONOMY

CONSUMER HEALTH

POSITIVE

U.S. GDP growth decelerated to a 2% annualized pace in Q3. The slowdown was driven primarily by supply chain constraints. Economists expect a modest acceleration in Q4.

CORPORATE EARNINGS

POSITIVE

With 95% of S&P 500 companies having reported Q3 results, sales and earnings are up 17.5% and 39%, respectively. However, company commentary suggests that the supply chain has been and will continue to be problematic in the coming quarters.

EMPLOYMENT

POSITIVE

The unemployment rate is down to 4.6%, as of October. The labor market is very tight at present as many employers, particularly in the Leisure and Logistics sectors, are struggling to fully staff because the labor participation rate remains below pre-COVID levels. The labor shortage is one of the causes of the global supply chain glut.

INFLATION

NEUTRAL

CPI rose 6.2% year-over-year in October, the highest increase since 1990, driven by the global supply chain backlog. Will inflation be transitory or permanent?

FISCAL POLICY

POSITIVE

A $1.2 trillion infrastructure bill was passed by Congress. $1.75 trillion spending bill passed by Congress and also sent to Senate for revisions.

MONETARY POLICY

POSITIVE

The Fed will begin bond tapering by November’s end. By mid-2022, all Fed bond purchases will halt. The Fed’s bong buying program works to keep interest rates low. Inflation concerns are persisting, and some are calling for faster tapering and high rates.

GLOBAL CONSIDERATIONS

GEOPOLITICAL RISKS

NEUTRAL

COVID-19 cases are surging in parts of EU (Austria and Germany) leading to further lockdowns.

ECONOMIC RISKS

NEUTRAL

Supply chain disruptions are hampering the economy; however, demand remains very strong. While global logistics are operating far below normal efficacy, it appears the supply chain is slowly improving and may reach normalcy by mid-to-late-2022.

The “Heat Map” is a subjective analysis based upon metrics that VNFA’s investment committee believes are important to financial markets and the economy. The “Heat Map” is designed for informational purposes only and is not intended for use as a basis for investment decisions.