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The buy-the-dip mentality drives markets to record highs

December 13, 2021

Thoughts

  • Equity markets continue to benefit from investors’ buy-the-dip mentality, as the S&P 500® Index saw its second-best week of the year last week to finish at the 67th record close of the year following a post-Thanksgiving decline. Bond investors remain more skeptical than equity investors, with the 10-year Treasury yield below 1.5% despite shifts in Fed Funds expectations and the yield curve remains near the flattest level of the year. Given the elevated inflation and low rates, real interest rates are at record lows.
  • Investor sentiment continues to show similar volatility to the equity market, with the CNN Fear & Greed Index bouncing to 38 on a scale from 0-100 from 20 a week ago. Bond spreads have recovered following a period of widening, while the VIX fell at the third-fastest weekly pace on record. While volatility remains elevated, retail investors have remained committed to equity markets, with Bank of America data showing a record allocation within private client accounts at 65% despite aging demographics.
  • While equity index returns continue to be impressive, the reliance on a small number of large-cap technology names masks some underlying stress. A broadening of leadership would be a positive sign for the sustainability of the rally.

News

  • All eyes will be on the global central banks this week, with meetings of the Federal Reserve, European Central Bank and Bank of England. Fed Chair Powell has recently shifted his tone, guiding that the FOMC will announce an acceleration of the asset purchase tapering to battle inflation. This would conclude the program around March rather than the original target of June, paving the way for rate hikes earlier than expected. The current “dot plot” shows only a 50% chance of a rate hike through 2022, though the Fed Futures curve shows a 60% chance of three-or-more hikes. The dot plot is expected to shift more hawkish following Wednesday’s meeting. Moderate Democrats are now pushing the Fed for tougher action against inflation as they worry about midterms. The ECB and BoE are not expected to shift their path due to renewed Covid fears.
  • The Omicron variant continues to be a concern to investors and is shifting return-to-work strategies for companies. The variant is highly infectious, but to date has caused mild symptoms, and the exiting vaccines provide strong protection against severe illness. While Europe is enacting incremental mitigation measures, there is little appetite for additional lockdowns or restrictions in the U.S., and President Biden has ruled them out.
  • Inflation continues to be a primary concern of investors, with a reading on consumer price inflation up 6.8% from a year ago was the fastest pace since 1982. Excluding food and energy prices, core CPI was up 4.9%, the highest in 30 years. The pressure was broad based, with energy prices up 33% (including gasoline up 58%), food prices up 6.1%, and shelter prices up 3.8%, the highest pace since 2007 during the housing bubble. Given that average hourly earnings rose at 4.8% in November, real wages declined by 2%.
  • Economic data continues to reflect robust activity, with the Citi Economic Surprise Index at the best level in nearly six months. A Bloomberg survey of economists reflects the expectation that growth remains strong, and inflation subsides in 2022. Risks remain elevated, however, including Omicron, inflation, the Fed, China, and energy prices.

What to Watch

  • Wednesday’s FOMC announcement will be the primary focus of investors this week. Economic data include producer price inflation and NFIB Small Business on Tuesday, retail sales on Wednesday, and housing starts, industrial production, and PMI data on Thursday.
  • This material is not a recommendation to buy, sell, hold or roll over any asset, adopt an investment strategy, retain a specific investment manager or use a particular account type. It does not take into account the specific investment objectives, tax and financial condition, or particular needs of any specific person. Investors should work with their financial professional to discuss their specific situation.

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