Equity markets have paused in the seasonally strong month of December, with the S&P 500® Index losing 2% last week. The “wall of worry” for markets currently consists of incremental Fed hawkishness (accelerated taper and higher rates), surging Omicron cases, continued supply chain pressures, and the failure of the Build Back Better plan. The tone of markets has quickly shifted “risk-off” despite hitting a record high a week earlier, with deteriorating breadth (weakest since last March) and momentum indicators. Value and defensives have taken the lead from growth and momentum. Commodity prices continue to retreat while Treasuries remain the safe haven with the 10-year Treasury yield below 1.40%. Despite the pullback, the S&P 500 has still returned 24% year to date and is 2% below a record close.
Sentiment has weakened among both retail and institutional investors. The Bank of America Global Fund Manager Survey showed cash levels rising to 5.1% from 4.4%. Participants are now a net 36% overweight cash, the highest level since May 2020, while equity exposure is at the lowest level since October 2020. Overall cash remains below average, however, given negative real rates, healthy corporate profits, and a growing economy. The most crowded trades are long technology, long Bitcoin, long ESG, short Treasuries, short China, and short emerging market currencies. The CNN Fear & Greed Index has moved close to an “extreme fear” reading despite record equity prices a week ago.
As we head into the shortened holiday week amid surging Omicron cases, continued supply chain pressures, and the failure of the Build Back Better plan, increased volatility and thinner trading volumes could cause the market to overreact, which could be a buying opportunity in the run-up to Christmas.
Senator Manchin said Sunday that he cannot vote for the $1.75 trillion Build Back Better domestic spending and climate package, saying the plan would “dramatically reshape our society that leaves our country more vulnerable to threats we face,” including debt and inflation. Democrats, however, still see a chance of reworking the bill to meet Manchin’s needs and get a plan passed early next year. Without a BBB plan, the odds of substantial tax changes have faded, including a 15% minimum tax for corporations, a tax on buybacks, and a surcharge tax above $10 million in income. Given the timing of taxes and spending package, the plan would have been a drag on S&P 500 earnings by roughly 3-5% in 2022.
The Omicron variant has brought cases in the U.S. to the highest level in four months, with a record number of cases in New York despite having the second-highest vaccination rate of any state. The White House continues to contend that lockdowns are unlikely, and that the booster shots work, an increasing number of countries in Europe have reinstated lockdowns. Goldman Sachs has already cut the outlook for 2022 global GDP growth on the outbreak.
Global central banks have shifted their reaction to COVID, with a greater focus on stemming inflationary pressure than boosting demand. The Fed unsurprisingly accelerated the pace of tapering following the FOMC meeting this week, with asset purchases now expected to conclude in March versus the previous expectation of June. They removed the word “transitory” when discussing inflation and acknowledged challenges in the labor force participation rate. “Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation,” the statement said. The “dot plot” shifted materially, with three rate hikes now baked in for 2022, compared with the previous expectation that there would either be none or one. The Fed futures curve went from forecasting a much more aggressive tightening path to a less aggressive. The dot plot sees the fed funds rate at 1.6% and 2.1% by the end of 2023 and 2024, while the curve sees 1.5% on both dates.
What to Watch
Volatility will likely be elevated this week as volume and participation is affected by the Christmas holiday. Notable economic data include revised third quarter GDP, consumer confidence and existing home sales on Wednesday, and durable goods, PCE deflator, consumer sentiment and new home sales on Thursday. The market will be closed on Friday in observation of Christmas.
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.
Nationwide Funds distributed by Nationwide Fund Distributors LLC (NFD), member FINRA, Columbus, Ohio. Nationwide Investment Services Corporation (NISC), member FINRA.