Hey!
I hope everyone enjoyed plenty of food with family and friends this past Thanksgiving! Unfortunately for investors, markets themselves didn’t really get a holiday. As we ended the month of November, a whipsaw of news within the past week has sent market volatility skyrocketing.
After a strong rally in October, markets started to stall out mid-month and have more recently began to sell off more aggressively heading into December. As the Federal Reserve tapering decision looms ever closer, the market has started to get very jumpy after a strong overall year. The nervousness has seemed to boil over in the past week as reports of increased tapering expectations by the Fed and the emergence of a new COVID variant threaten additional upside momentum into the new year.
Let’s talk about the various market factors in play and what you should be thinking about in this environment coming into the end of the year.
First though, these newsletters are meant to be informational and educational only. They are not financial advice, and I am not a financial advisor. Always do your own research before investing any of your hard-earned money into something!
Letter Highlights
· Spotlight on Federal Reserve Tapering Plans
· Omicron Variant Emerges
· Government Out of Money?
Index Year to Date Gains Through End of November
· S&P 500 +22.25% (+0.25% mo./mo.)
· Nasdaq +24.75% (+2% mo./mo.)
· Dow Jones +12.8% (-3.25% mo./mo.)
· Russel 2000 +10.6% (-4.8% mo./mo.)
· Bitcoin +92% (-6.75% mo./mo.)
· Ethereum +530% (+8.75% mo./mo.)
Spotlight on Federal Reserve Tapering Plans
As I have discussed in past letters, the Fed’s tapering plans have been the most important thing market participants are paying attention to. Over the past year and a half, the central bank has engaged with loose monetary policies through quantitative easing (QE), seeking to increase the economy’s liquidity amid the COVID pandemic. Now, as the American economy gets back to its feet, concerns over inflation have picked up and calls for a tapering of QE are loud and clear.
As it turns out, inflation is not ‘transitory’ as we were previously led to believe. Is the Fed finally starting to recognize this as a reality?
During a Senate hearing on Tuesday, Fed Chair Jerome Powell indicated it was time to retire the word ‘transitory’, a clean and clear admission from Powell that inflation is no longer transitory. In addition to this, Powell also stated that “the threat of persistently higher inflation has grown.”
With inflation at the highest levels it’s been at in 30 years, reported at over +6.2% in October, increased pressure has been placed on the Federal Reserve to reign in rising costs and ease up on their monthly asset purchase program (QE).
With the S&P index up over 20% for the year, many investors are starting to fear the indexes have been propped up by the easy Fed monetary policy and the massive $120b a month asset purchasing program.
With all that excess liquidity floating around in the system, the removal of that massive monthly stimulus too quickly could definitely bring markets down with it. Currently though, indexes are still sitting near all-time highs with company valuations still at stretched levels. There is plenty of room for downside contraction if the market sours on the Fed’s game plan.
Last month however, investors were able to digest remarks from the Fed outlining a gradual taper plan would begin in December. It was indicated the reduction would be $20b a month.
The market took this news well and viewed the plan as an acceptable route to ween off the easy money and allow valuations to gradually normalize. The eventual normalization of the Fed balance sheet could also ease inflationary pressure. The market likes certainty. A transparent plan of action allows for clarity on forecasting and outlooks.
However, as the Thanksgiving holiday loomed, a report from JPM emerged stating that the Fed would be looking to drastically speed up its tapering plans. This seems all but confirmed now after remarks from Fed Reserve chair Jerome Powell as he testified before the Senate on Tuesday.
In prepared remarks, Powell indicated that the Fed may need to accelerate the tapering of its monthly bond and mortgage purchases to keep inflation from overheating.
“It is appropriate, I think, for us to discuss at our next meeting, which is in a couple of weeks, whether it will be appropriate to wrap up our purchases a few months earlier,” Powell said Tuesday. The FOMC meeting is scheduled for December 14th.
With the markets previously anticipating a reduction of about $20b a month from the $120b monthly asset purchase plan and a normalization by mid-2022, a larger reduction was mostly not priced into market projections. With a larger taper, the Fed could be looking to normalize its balance sheet by early spring, allowing for flexibility to raise interest rates in late 2022.
As I have said before, the market will throw a tantrum if the easy money is taken away too quickly. Stretched valuations will contract and a lot of the gains will be sucked out of the market.
This puts the Fed in a tough spot. It’s become obvious that the Fed cannot allow markets to completely crash, but what can they do? Inflation will continue to remain high if the Fed does not normalize its balance sheet with intent to raise interest rates, yet by doing this a lot of the froth in the market will be drained out as the crazy valuations cannot be sustained without easy money coming into the system.
With the FOMC meeting a few weeks away, I anticipate some increased volatility during this time of uncertainty and as investors look to position themselves for the most probable outcome.
Omicron Variant Emerges
To further complicate the situation, last week reports began to drop regarding a new COVID variant, since dubbed ‘Omicron’. Initial reports indicated this variant out of South Africa had numerous mutations and that vaccines may not be as effective.
With a half day on Black Friday, the market reacted negatively in a strong way to this news when it opened up. The news was immediately seen as a negative catalyst to re-openings and supply chain constraint easing.
Although, with potential restrictions and economic slowdown looming given this, the new variant could serve as a catalyst for the Fed to take a slower approach to tapering QE.
This could cause some short-term upside momentum to close out 2022, but longer-term implications of the Fed eventually normalizing its balance sheet will put pressure on the market even if it does come at a slower pace.
We also still do not know the full impact Omicron will have on the economy. Data is still being collected and there appears to be cases already within the U.S. Given this stage of the pandemic, I do not foresee large scale lock downs or major restrictions being put in place.
As of right now, the U.S is not considering additional lock downs. That’s a good thing. Additionally, based on comments from vaccine manufacturers, they seem confident the efficiency of the available vaccines would remain high.
Given the already high rate of inflation and increased pressure to rein in costs, I anticipate the Fed will look to push forward with tapering plans. To what pace and extent, we won’t know until December 14th.
Before the meeting we will also get November’s inflation rate on December 10th which no doubt will be high.
Government Out of Money
Oh, I almost forgot to mention the government debt limit will be topped out on December 15th. Probably nothing, right? This has been a known issue for politicians for quite some time now.
Also in Senate remarks Tuesday, Treasury Secretary Janet Yellen stated, “I cannot overstate how critical it is that Congress address this issue. America must pay its bills on time and in full.” Failing to act on the debt limit would "eviscerate our current recovery," Yellen said.
As I’ve mentioned in the past, although scary and pretty messed up, I expect the government to increase or eliminate the debt limit in the last hour. Democrats alone have the power to do so now if they choose. Until then, this only adds increased unrest to an already jumpy market.
Final Thoughts
Given the increased uncertainty regarding various factors surrounding monetary policy, expect some wild price swings in the coming weeks leading to the FOMC meeting. Its pretty clear the government has a money problem. What happens next could have long term implications.
The U.S. monetary policy remains one of the key factors for the market’s direction. A strong jobs recovery, easing of supply constraints and a successful tapering plan would be a healthy thing for the market’s durability.
With that said, as the U.S. central bank carelessly maneuvers the economy at a whim, citizens can reclaim control over their finances with Bitcoin. The peer-to-peer monetary network based on open-source code and an inelastic supply differs from the financial system in chaos, backboned by soft fiat currencies. With a limited and programmatic supply, Bitcoin offers certainty and fairness to anyone that adopts it, enabling them to save and build wealth for the future, regardless of what policymakers choose to do next.
We live in an age where education and information on anything we want to know is accessible at our fingertips through the internet. You owe it to your future-self to become educated in money management.
By signing up for this newsletter you have already taken steps to accomplish that. Stay consistent on your journey and don’t stop learning.
Catch ya later!
Bryan Craig
Lefty Group Capital Chief Investment Officer
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