by William Henderson, Vice President / Head of Investments
Last week the markets shrugged off Omicron-related news and strong November inflation numbers as all three major indexes closed higher. The Dow Jones Industrial Average jumped by +4.0%, the S&P 500 Index rose by +3.8%, setting a record, and the NASDAQ gained +3.6%. With fewer and fewer days left in the year, we are moving to close 2021 out with some near record levels on all three major indexes, giving us quite a year of overall returns. Year-to-date, the Dow Jones Industrial Average has returned +19.7%, the S&P 500 Index +27.2% and the NASDAQ +22.0%. As mentioned, the year-over-year CPI (Consumer Prices Index) for November was reported at +6.8%, the highest reading on inflation since 1982. This information gives Fed Chairman Jay Powell the ammunition needed to consider moving interest rates higher before June 2022, which was the previously telegraphed date. We will get some further direction this week at the FOMC (Federal Open Market Committee) meeting December 14-15. The 10-year U.S Treasury ended the week at 1.47%, seven basis points higher than last week and still below 1.74% level reached in March of this year. 

Chairman Powell will consider the Fed’s so-called “dual mandate,” 1) average inflation at 2% and 2) unemployment rate at 4.1%. See the chart below from Factset which shows we are nearing the point where both mandates are being met.   

It is likely that the FOMC announces a faster pace in their balance sheet tapering process. Currently, they are tapering (reducing purchases of bonds) by $15 billion per month; an increase to $30 billion per month is likely. At that rate, the Fed would wind down the tapering process by March of 2022, thereby allowing the start of the rate hikes, if needed. At any rate, we expect rate hikes to be clearly telegraphed, measured and incremental. 

A lot of noise is being made about rates hikes and the Fed “Hawkish Pivot,” meaning a Fed that will raise rates rather than keep them lower. Certainly, interest rates at the Fed’s current target range of 0.00 – 0.25%, are accommodative to economic growth, but interest rates at 100 or even 200 basis points higher are still considered accommodative by historical standards. We are not predicting huge interest rate moves like that, but it seems to us that higher rates are inevitable. When we look at the Fed’s last tightening cycle (December 2015 – June 2019), interest rates moved from 0.00% (post the Great Recession) to 2.50%. During the period, the S&P 500 Index moved higher by 57% (or 11% per year). Of course, past performance is never a preview of future performance, but we showed that data simply to prove that markets can move higher even while the Fed removes monetary accommodation.   

Lastly, even while the Fed begins to raise interest rates, we expect bonds to continue to offer investors an important risk management tool – critical to their portfolios. A look at the current U.S. Treasury 10-Year Breakeven Inflation Rate shows the level at 2.44% (Federal Reserve Bank of St. Louis). The breakeven inflation rate represents a measure of expected inflation derived from 10-Year Treasury Constant Maturity Securities and 10-Year Treasury Inflation-Indexed Constant Maturity Securities. The latest value (2.44%) implies what market participants expect inflation to be in the next 10 years, on average, well below the 6.8% inflation number released last week.   

Watch for retail sales data this week as we get our first glimpse of holiday shopping data. Further, early indications show supply chain issues are slowly getting worked out in West Coast ports as we showed last week with falling shipping rates (China to U.S.). The Omicron variant’s impact seems to have abated a bit in the U.S. while the opposite is happening in the U.K and elsewhere globally. The Fed and the Biden Administration have their hands full and will need to decide where, when and how to remove monetary and fiscal stimulus, both of which have powerfully and effectively fueled strong price inflation in goods and services. Wall Street trading desks will be thinly staffed for the next few weeks; so, watch for limited volatility but remain focused on your long-term goals. 

by William Henderson, Vice President / Head of Investments
All three major market indexes closed lower last week as a poor jobs report on Thursday added to hawkish comments by Fed Chair Jay Powell suggesting a more aggressive pace of bond purchase tapering and sooner rate hikes than previously announced. The market also continued to react to the implications of the new omicron variant of COVID-19. The Dow Jones Industrial Average fell by -0.9%, the S&P 500 Index dropped by -1.2% and the NASDAQ lost -2.6%. While a poor week overall, major indexes remain in positive territory for the year. Year-to-date, the Dow Jones Industrial Average has returned +15.1%, the S&P 500 Index +22.5% and the NASDAQ +17.8%.  Even in the face of potential monetary tightening, the U.S. Treasury market rallied and forced bond yields lower. The 10-year U.S Treasury ended the week at 1.40%, a full 13 basis points lower than last week and confoundingly lower than the 1.74% level reached in March of this year. Bonds continue to offer safety and risk management when risk assets (e.g., equities) sell off. 

As mentioned above, according to Bloomberg, the employment report showed only +210,000 new jobs were created in November 2021 vs. economists’ expectations of +550,000. On the surface this number is bad news, but this data point is sometimes unreliable and often subject to revisions in later months. If you unpack last week’s economic releases, we believe there is strong forward momentum in the employment situation and the economy. First, the unemployment rate plunged to 4.2% vs. expectations of 4.5%, clearly suggesting more people are returning to the workforce. Second, the Labor Force Participation rate moved to a post-pandemic high of 61.8%. (See the chart below from the Federal Reserve Bank of St. Louis). 

A report by Cornerstone Macro last week pointed to two articles that highlighted teenagers and retirees might be lured back to the workforce soon: “Teen Hiring is Snowballing Amid Staffing Crisis, Rising Entry-level Pay “(USA Today 12/1/21). And “Short on Transit Workers, Cities Pay Bonuses to Lure Back Retired Staff” (NY Times 12/1/21). (See the charts below from Cornerstone Macro showing significant improvements in average hourly earnings for employees in the Leisure, Hospitality and Retail sectors – all classic places for younger and / or newly retired workers.) 

Lower unemployment and wage growth will continue to act as an economic tailwind and propel the recovery farther and longer.   

While the impact of the new omicron variant is still being digested, the markets are not yet panicking. More specific information about omicron’s transmissibility, virulence and resistance to vaccines needs to be discovered. However, early reports suggest while more contagious, omicron has relatively mild symptoms and the widely available booster shots could offer a considerable degree of protection. Lastly, biotech and medical developments over the past year give us some degree of confidence that the latest setback will not lead to a repeat of the early-2020 pandemic days and resultant economic lockdowns.    As we move to the close of 2021, let’s keep the important things in focus: the economy is clearly on a path to a strong recovery, employment activity is healthy and growing broadly across all sectors, corporations remain strong and continue to invest in capital expenditure and finally the consumer remains the backbone of the economy and is poised to continue to offer support well into 2022. Market selloffs and setbacks are to be expected, especially at year end as trading desks are thinly staffed and investment banks are reluctant to offer liquidity. Here at VNFA, we are already focused on 2022 and long-term returns.