Markets pause as volatility spikes and sentiment collapses
December 06, 2021
Equity markets struggled for the second straight week, with volatility stemming from worries about the Omicron variant and an increasingly hawkish tone from the Federal Reserve. Following a period that saw no 1% directional moves since mid-October, the S&P 500® Index has now seen one in five of the past six. Investors have experienced a flight to quality, with small caps down 11% over the past month and the 10-year Treasury yield below 1.40%. Crypto is struggling in the risk-off environment, with Bitcoin down nearly 30% since November’s high. Following the strength seen in the market this year, a period of consolidation is not unhealthy or unexpected. Volatility could remain elevated given a vacuum of news though year end, but strong seasonality and the fundamental backdrop provide a tailwind.
Investor sentiment has seen a notable inflection, with the CNN Fear & Greed Index touching 20 (“extreme fear”) on a scale from 0-100 on Friday, down from 85 a month ago (“extreme greed”). Other metrics echo the shift, including the AAII Sentiment Survey showing bears at the highest level in a year and the put/call ratio at the highest level of the year. The sentiment deterioration has not yet driven a shift in flows, with $1 trillion in retail flows into equity funds and ETFs this year and equity allocation near a record high.
Market volatility has increased as sentiment has collapsed, but tailwinds remain in place for markets through year end.
The Omicron variant continues to worry investors as it has now spread to 17 states, but Dr. Fauci notes that we are not seeing a surge in hospitalizations, suggesting it does not look like “there’s a great degree of severity to it”. There are signs that the variant may have picked up snippet of common-cold virus, meaning it transmits more easily while only causing mild or asymptomatic disease. Vaccine demand in US spiking amid expanded eligibility of booster shots and fears of Omicron variant.
The Fed is on track to accelerate the taper following a payroll report showed a decline in the unemployment rate to 4.2% from 6.7% a year ago. The taper could accelerate from $15 billion a month to $30 billion a month when they meet next week, which could wrap up the taper by March, allowing a sooner-than-expected hike to the Fed Funds rate. The futures curve currently embeds a 57% chance of three-or-more hikes next year, while the “dot plot” only shows a 50% chance of one hike. The PBOC is heading in the opposite direction, cutting the required reserve ratio to stimulate the economy and revive the slumping property market.
Democrats in congress are racing to finish legislation by year-end following the passage of a resolution to keep the government open last week. This week’s focus will be on the National Defense Authorization Act, which faces increased complications given recent actions by Russia and China. This was due by the end of September, and failure to pass could impact service hazard pay, construction projects and foreign aid. Congress is also facing a deadline for the debt limit, which could be necessary by mid-month. Leadership continues to work on the Build Back Better plan, with the goal to have it passed by the end of the year.
What to Watch
Inflation data will be in focus in a relatively light week of data, with a reading on CPI on Friday. Other data include consumer credit on Tuesday, JOLTS job openings on Wednesday, and consumer sentiment on Friday.
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