You’re a Mean One, Mr. Grinch
What was expected to be a happy and cheerful kick-off to the holiday season quickly turned nasty in the markets, leading many to now wonder if there is going to be a Grinch to play spoiler this year. Fears surrounding a new Covid variant, being dubbed “Omicron,” and potential lockdowns sent shockwaves through the markets on Friday with US equity markets having their worst day since February, on what was a shortened trading session following the Thanksgiving holiday. The impact was felt not only by stock markets but also commodity prices, namely oil, and the bond markets with a “flight to quality” from stocks into bonds, pushing yields lower and prices higher.
Prior to the coronavirus news, the markets were expected to be focused on retail sales and consumer spending as the holiday season officially kicked off. Indications are consumer spending remains strong, which was reflected in the Personal Consumption Expenditures (PCE) figures released last week. It has also been reported that retail sales in the month of November are very robust as many people started their holiday shopping early. This seems to have carried through to Black Friday with preliminary reports of solid spending, both in stores and online, at a pace 10% greater than last year. With supply chain constraints garnering headlines, some shoppers may be worried about inventory and higher prices so therefore are trying to get an early jump to ensure they can find what they want.
Earnings reports from numerous retailers last week showed strong sales and revenues in the third quarter but earnings were lower than expected due to higher expenses, especially elevated shipping costs related to higher fuel prices. There was also mention of limited inventory in some reports as a result not only of shipping issues but also factory output being limited, primarily overseas, due to shutdowns over concerns of virus spread as well as ongoing labor shortages. There have been early signs the worst of the supply chain bottlenecks, shipping issues, and labor shortages are behind us and conditions are improving, however that may now come into question with the coronavirus surge and continued shortages of raw materials.
We cannot go a week without mentioning inflation, especially since last week the PCE Deflator data was released, which measures the change in prices of goods and services included in Gross Domestic Product (GDP) and happens to be the Fed’s preferred measure of inflation. The Federal Reserve (“Fed”) has publicly stated they are targeting inflation of 2% and would be comfortable with inflation up to 3%, however the reading last week showed inflation being 5% on a year-over-year basis so well above their comfort zone. With recent gauges all showing sustained, and even accelerating, levels of inflation there is now intensified speculation the Fed will speed up the taper, or reduction, of their monthly bond buying program as well as increased chances of multiple interest rate hikes in 2022.
Coal in Your Stocking
It would be nearly impossible to not be aware of what energy prices have done over the past year with oil and natural gas prices spiking much higher, impacting the cost to operate motor vehicles and heat our homes. Given that energy is a large input cost for transported goods this
has been a major contributor to the rise in inflation over the past several months. Multiple forces remain at play within the energy markets as last week the Biden administration announced the release of 50 million barrels of oil from the Strategic Petroleum Reserve (SPR). On the day this was announced, oil prices moved higher, contrary to the expectation they would move lower when larger supply was going to be made available. Why is this? It could be the release was not as large as expected and new concern this will affect the actions of OPEC, whose members prefer higher prices. Previously it was widely expected that OPEC was going to increase production but now the thought is they might instead decrease production to counteract the SPR release which could possibly lead to a price war. As a point of reference, the U.S. consumes about 20 million barrels of oil per day so the 50 million barrels being released most likely will not have a significant impact on longer term energy prices.
Despite the SPR release announcement and price action earlier in the week, oil prices took a major hit on Friday trading about 12% lower from what was “panic” over reduced demand should shutdowns again occur. We remain anxious to see how oil prices react in the coming week since trading was very thin on Friday due to the holiday and the potential impact of the Omicron variant is more widely determined. Our guess is that prices will rebound, but maybe not all the way to where they were early last week. Also of note is that natural gas, which is less affected by shutdowns and driven more by demand for heating and power generation, traded 5% higher on Friday so notions of lower energy prices leading to lower levels of inflation are probably premature.
As this week kicks off attention will be on news about the new Covid variant and what impacts it might have. Over the weekend indications are that while perhaps more contagious than other strains, this variant is milder with symptoms similar to the common flu. Our thought is that we have been hit with the initial fear which will subside and the stock markets will quickly recover. The market’s reaction to the virus is not based directly on the virus itself but rather the prospect of shutdowns and what impacts those might have on the economy. While there have recently been full shutdowns in some European countries we find this high unlikely here in the U.S., especially given how politically unpopular lockdowns have become. Also, trading has historically been volatile with low volume on the day after Thanksgiving, so we would guess that cooler heads will prevail when the “adults” come back to work this week.
At this point we are not changing our market outlook but will maintain a vigilant watch on developments and potential impacts. Let us all hope this does not derail the economic recovery and play Grinch to this holiday season nor set us off on a bad foot to begin 2022; scenarios which we presently deem to be unlikely. If you would like to discuss portfolio positioning or ways to protect against a market downturn please give us a call to discuss your individual situation.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
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