Market Update December 2021 – Inflation: You Can’t Recover Without It…
COVID strikes again with the Omicron variant. The fall of 2021 has taken on the “two steps forward, one step back” model. As the recovery strengthened through the summer, September stole October’s reputation for volatility in the fall. But October had the last laugh with a seven percent gain by the S&P 500 index, setting the stage for the much anticipated year-end rally.
The pieces all looked to be in place for further market gains led by a rotation into the less-expensive, economically sensitive areas of the equity markets as favorable conditions continued to build. First though, a celebration with family over turkey and football, then back to finish the month and reposition for the next market phase to play out into the new year. Except for news coming out of South Africa.
A new, highly contagious COVID 19 variant had been identified. After the experience of the past 19+ months this couldn’t be ignored, and market volatility picked up again. Sell first, ask questions later.
But something was different. Fear of the unknown didn’t drive the equity markets down 30+% as it had in March of 2020. This time, as measured by the S&P 500 index, the market was down just over 4% in the following days. Wait, only -4%? Even more notable given that this news hit US markets during one of the lightest traded days of the year, the Friday after Thanksgiving.
Admittedly, investors are still in the process of sorting out current conditions. Further volatility may occur as not only the Omicron variant, but also shifting Fed policy are sorted out. Yet, it’s important to not overlook investors’ initial reaction during this time. Actions speak louder than words and recent actions suggest investors are adjusting to an environment where (1) these types of episodes are possible (2) they do not necessarily signal an immediate, sharp decrease in business activity – ala March 2020 (3) policy makers in all disciplines will be proactive and look to respond quickly (for better or worse, but that’s for another discussion).
Additionally, businesses are also better prepared to continue operating. While it was more difficult for some than for others, survival required companies to figure out how to operate under several potential scenarios. Possibly the best example is the ability for companies to function remotely, a trend that has been in place for some time but was accelerated out of the need for survival.
Each of these items support investors’ more muted response to the Omicron variant. But is this complacency? Unlikely. Since Thanksgiving the broad market has remained in a range, signaling neither complacency nor fear. And as we near year-end, the same list of items is likely to remain in the forefront of investors’ minds. Current conditions remain favorable for equities, supported by items such as December’s release of various employment data, reporting further growth in both employment and earnings. And evidence supporting receding supply-chain issues.
While these trends look to be favorable, they’re certainly not guarantees. Will the Fed policy makers be vocal through year-end? Are there more COVID-related surprises? As we’ve learned during the past two years, the unknown can show up without an appointment. But as we move towards year-end, investors will do well to act on what is known and stay ready to react to what becomes known.
Thanks much for taking a look at the Market Updates and Charts of Interest in 2021. We’ll look forward to reconvening in 2022!
CHART OF INTEREST: Inflation: You Can’t Recover Without It…
When economic growth slows it is not unusual to also have slowing inflation. And the economic hard-stop of March 2020 certainly caused an abrupt slowing in inflationary measures as evidenced by the year-over-year Consumer Price Index (CPI YoY) falling from its January 31, 2020 level of 2.5% to a low of 0.1% as of May 31, 2020. This is quite a stark difference when compared to the more gradual declines and recoveries of past recessions.
Following a recessionary period, a sharp rebound with rising inflation data may invoke concern. Is it a growing threat? Or is it a temporary condition in 2021 (“transitory” in Fed speak) reflecting an equally sharp reversal, as the “reopening” portions of the economy ramp back up their businesses?
While it’s not an easy question to answer, the chart below provides a unique look at the sources of inflation, broken out in a manner providing some context to answer the “transitory” question. The three categories represent groups having differentiated impacts on inflation. The “non-reopening” group reflects businesses that were relatively active through the early months of the pandemic. The “reopening” group, as listed, experienced significant disruption during the pandemic. As a meaningful contributor alone to CPI the “energy” group is impacted by unique global aspects affecting its impact on inflation.
Year-to-date in 2021, this analysis provides insights for considering the future trend of inflation. The “reopening components” look to be sensitive to the changing social narrative regarding COVID-related concerns. This group were large contributors to CPI in April – June but backed off quickly as fall approached. The “non-reopening” components have been rising steadily throughout the year and may be the most concerning group with regards to concerns of further above average inflation. And energy is, as always, a wild card given influences such as seasonality and sensitivity to global powers such as OPEC.
As inflation is largely tracked by CPI YoY, the future of its current trend may look to point towards higher inflation. But it must be remembered that future data is a comparison of today with one year prior. And in the same manner that portions of the economy experienced an abrupt stop, the restart, while not as sharp, is also proceeding much more quickly than typical economic cycles. It remains to be seen if current inflationary pressures will continue or if this is a period of catch-up to be followed by a moderation of future inflationary pressures.
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