Week ended December 3rd, 2021
“Your success in investing will depend in part on your character and guts and in part on your ability to realize, at the height of ebullience and the depth of despair alike, that this too, shall pass.”
Jack Bogle, Founder and former CEO of Vanguard
It was a highly volatile week in global financial markets. It all started late the week before with the arrival of the new Omicon variant. Concerns broadened this week as investors had to not only contend with the uncertainty of Omicron, but also with the Fed walking back its “inflation is transitory” argument mid-week, followed by Friday’s mixed jobs report (for November). These events all had effects on the US equity and bond markets, as volatility surged mid-week to levels not seen since the onset of the pandemic. Shorter-dated USTs got hammered whilst intermediate and long-term USTs rallied hard, causing the yield curve to flatten. Corporate bonds seemed to shrug it off. Although spreads and yields in the investment grade and high yield bond markets remain off their lows of several weeks ago, corporate bonds suffered no significant visible effects this week (through Thursday) from this week’s heightened financial markets volatility. As investors moved into the safety of intermediate and long-dated US Treasury bonds, other safe haven assets behaved more or less as they have through much of the year, at least as far as gold (slightly weaker) and the US Dollar (slightly stronger). Perhaps more telling is the fact that Yen reversed course and has come off its lows from a few weeks ago, strengthening into uncertainty as it normally does during periods of risk-off sentiment. Oil suffered another highly volatile week, too, but by the end of the week had resumed its march downwards. Cryptocurrencies bounced around but seemed to maintain their stern face much of the week as other markets wobbled. However, this morning (Dec 4th) as I am writing this, Bitcoin looks to be in a meltdown mode, off nearly 17% since last night’s price. Although we sometimes forget, the fact is that volatility in cryptocurrencies make gyrations in stock and bonds prices seem like a walk in the park!
As far as equities, it is interesting to note that with turmoil all around us, the S&P 500 was only down 1.2% W-o-W. In other global equity markets, the FTSE 100 and the Shanghai Composite both notched gains W-o-W, up 1.1% and 1.2%, respectively. (Yes, I did go back and check the FTSE 100, and it was surprisingly up.) The emerging markets index also gained slightly (thanks to China), with the worst performer for the week being the Nikkei 225.
In US equities, it was not pretty anyway you look at it. Let’s start with market volatility. Recall that the VIX (“fear index”) jumped nearly 10 points during the initial Omicron scare the Friday after Thanksgiving, but then appeared on its way to settling on Monday as the buy-the-dip crowd showed up to grab what they thought might be bargains. However, things started to unravel again during Mr Powell’s and Treasury Secretary Yellen’s Q&A by the Senate Banking Committee, which took place on Tuesday and Wednesday. Although the VIX briefly settled back below 23 on Monday, it reached an intraday high of 35.32 during Friday’s highly volatile session before closing the day (and the week) at 30.67, the highest closing level for the VIX (aside from two days before) since late January. With this backdrop, it is actually surprising that US equities didn’t perform worse. Looking at the trends amongst the major indices, the more economic-sensitive but concentrated DJIA had the best relative performance W-o-W, down a mere 0.9%. The small cap proxy Russell 2000 and the tech-heavy NASDAQ Composite both performed much worse, down 3.9% and 2.6%, respectively. It is my instinct (not data validated) that the underlying trends in US equities are much worse than the indices suggest because the performance of the indices have been skewed by the resiliency of some of the large-cap names, including the likes of AAPL, TSLA and NVDA. However, the positive influence of these large-cap tech names started to fade on Friday, as the uncharacteristically high valuations of some (like TSLA and NVDA) started to weigh on their stock prices. The sell-off of high-flyers, many of which have been darlings of retail investors since the pandemic, accelerated. Many of these stocks are ARKK and Motley Fool focused names, and some have appreciated by 300% or more from the start of the pandemic until early 2021. However, it is clear now that reality has set in as far as valuations of these companies, many of which are not even profitable. I just saw something on Twitter on the compression occurring in price-to-sales ratios for many of the high-flyer stocks, and it is severe and will likely have further to go. The carnage amongst the high flying names seems to be accelerating as investors sift through what they believe to be the winners and the losers, but there is a heavy over-riding downward bias across the board on most of these names. I have said on several occasions that this sort of correction was coming, but the timing and severity of the price action is far from predictable. Perhaps this difficult week will right itself and – like other mini-corrections since the pandemic – will be forgotten in a matter of days. The difference this time though is that the Fed, which has had investors’ backs through its “forever easy monetary policy” approach, has said for the record that it will be tightening, no doubt sooner than investors were expecting.
The table below shows how the US stock indices performed last week.
Changes in yields in the US Treasury market and the shape of the yield curve are the best predictors as far as where investors believe that the US economy is heading. Of course, the UST market is also highly influential as far as stock prices. You needed to look no further than this past week to see this relationship in action. Other than the Omicron variant – which nearly everyone suspected would quickly spread to all parts of the world (1) – the most influential news came from Fed Chairman Powell in his testimony before the Senate Banking Committee mid-week followed by a mixed November jobs report on Friday. Much of the Banking Committee’s questioning seemed to gravitate around inflation, and Mr Powell provided a rather unexpected tilt towards hawkishness by retiring the word “transitory” on the spot, suggesting that the current taper might accelerate and that lift-off might occur earlier than expected. As expected, this spooked markets although it was always going to happen at some point as the slew of worse-than-expected inflationary data kept coming out. Of course, yields at the short-end of the US Treasury market raced higher as a possible Fed Funds hike was brought forward, even as yields plummeted at intermediate and long maturities as investors tempered their economic growth expectations (and sought safe havens, certainly a factor, too). The price of the 2y UST plummeted whilst the price of the 30y UST bond price rocketed up. The yield on the 30y UST has now reached its lowest level since the very beginning of this year, whilst the yield on the 2y UST has reached its highest level since the beginning of the pandemic. The 2y-10y difference has also reached its lowest level since late 2020 as the yield curve has flattened in anticipation of what lies ahead given the new path of the Fed withdrawing its ultra-accommodative stimulus. On Friday, the Bureau of Labor Statistics released the November employment report (here). It was somewhat mixed in that new jobs fell well short of expectations, although the unemployment rate fell sharply to 4.2% and the labour participation rate nudged higher. Investors interpreted this data as further support for the Fed’s newly articulated path of faster tightening to address increasing inflation.
Even as investors fled to the safety of US Treasuries and equity volatility increased, other safe havens had less interesting weeks. The US Dollar and Yen edged higher, whilst the price of gold scarcely moved.
The price of oil continued to fall, off nearly 3% W-o-W and now down 21% from the price just one month ago. OPEC+ announced that it planned to stick to its increase in production of 400,000 bbls/day staring in January, in spite of concerns that global economic growth might slow due to the uncertainty of the Omicron variant and the Fed’s hawkish tilt. OPEC+ will most certainly reduce or even eliminate its supply increase slated for January if global demand wanes and the price of oil continues to decline. Bitcoin ended the week about flat, but has since plummeted this morning, down to $47,000 (-17%). ETH has been less affected but has also sold off, too, as have much of its cryptocurrency brethren.
Note 1: According to WHO as the time I am finishing this, the Omicron variant has now appeared in 38 countries. No deaths have yet been attributed to this variant.