Monthly Market Review December 2021

By: Andrew J. Willms

President and CEO, The Milwaukee Company

Economic Highlights.[1]

The price Americans pay for goods and services jumped 0.6% in October, according to the government’s personal consumption expenditure price index. Over the past year, those prices surged by 5%, up from 4.4% in September. That’s the highest level since December 1990. Meanwhile, the most recent Consumer Price Index (CPI) showed the cost of living rising at a 6.2% yearly rate, a 31-year high.
After accelerating for 16 consecutive months, the pace of growth in U.S. housing prices eased slightly in September. However, the Case-Shiller National Home Price index is still increasing at a high year-over-year pace: 19.5%, which is well above the near-15% peak posted during the 2005-2006 housing bubble.
The U.S. economy managed to add 531,000 jobs in October of 2021, well ahead of expectations and September’s modest 194,000.
U.S. GDP is believed to have grown more than 6.5% in 2021, and is forecasted to grow by more than 4% in 2022, both of which are well above the 2%-3% range that’s prevailed for much of the past decade. The Eurozone is expected to expand by 4.8%, while Asia (ex-Japan) is predicted to grow 7.1%.
The University of Michigan’s Consumer Sentiment Index dropped to 63.5 for November, its lowest reading in a decade and down from 67.9 in October.

Stock Market Highlights.

The Dow and the S&P 500 both lost ground in November, while the Nasdaq managed to eke out a 0.25% gain.
- As recent market activity has demonstrated, the exceptionally high valuations at which stocks are trading suggest it would not take much for stocks to reverse course.
- Nonetheless, most of the major players on Wall Street are predicting stock prices still have more room to run on the upside.
Covid-19 continues to be the biggest threat to the bull market.
- The detection of a new coronavirus variant and thin holiday trading combined to push stocks down sharply last Friday. The S&P 500 fell 2.3% on November 26th.
- Susan Hopkins, chief medical adviser to the U.K. Health Security Agency, said the new variant has the potential to be the most dangerous yet. It appears to spread quickly, and it's not yet known how effective existing vaccines are against it.

One possible warning sign for stocks: there has yet to be a daily decline for the index of more than 3% in 2021. In 2020 that happened 16 times.

Bond Market Highlights.

President Biden’s decision to renominate Federal Reserve Chairman Jerome Powell reinforced perceptions that the central bank will continue to taper its easy-money policies in an effort to slow rising consumer prices.

Federal Reserve Chairman Jerome Powell warned Congress that while the Fed continues to expect inflation will ease "significantly" over the next 12 months, it “now appears that factors pushing inflation upward will linger well into next year.”

Some wonder (myself included) if the Fed is essentially planning to close the barn door after the horse has already left the barn.

One thing is for sure -- interest rates have not been keeping pace with rising inflation. With a 10-year Treasury yield of just under 1.5% at the end of November, and inflation (measured by CPI) accelerating to a 6.2% annual rate, the “real” 10-year yield is approximately –4.7%, a record low.

Commentary.

This newsletter includes an article I wrote that expresses my belief that market prices are the best indication of what a stock or bond is worth. But I must admit, the low yields bond investors are settling for, and the stretched valuations at which stocks are trading, have me wondering if Mr. Market might have started his holiday celebration a bit early this year. Consider:

The inflation rate hit a 30-year high and interest rates fell.

The Fed signals it will begin unwinding its stimulus program and Mr. Market yawns.

When reflecting on what has been transpiring in the markets recently, it’s hard not to feel like legendary football coach Vince Lombardi, when he exclaimed “What the hell is going on out there?” in the midst of a poor performance by his Green Bay Packers.

While there are certainly reasons for questioning the sanity of market participants, upon closer examination, Mr. Market seems to be behaving quite rationally.

Yes, the stock market is near all-time highs, but there are several sectors of the market that have been getting spanked recently, including tech and meme stocks, which have seen the biggest runup in prices.

Meanwhile, market sectors that stand to benefit from inflation, such as financials, energy, and commodities, are seeing their fortunes reversed after years of trailing the overall market.

Fear and uncertainty are among the key factors behind a rush to buy bonds.

The potential for Omicron coronavirus variant to impact the speed at which the Fed raises interest rates and taper monthly asset purchases is another compelling reason for rates to remain low in the face of higher inflation.

Does that mean stock prices won’t reverse course or interest rates won’t rise in 2022? Not necessarily. I remain concerned about the high prices at which stocks are trading and the elevated degree of speculation being exhibited by day traders. I am also of the opinion that the low rates being paid on long-term bonds are not sufficient to compensate the risk that is inherent in them.

But accurately predicting where stock prices and bond yields will go in 2022 is a 50/50 proposition at best. As baseball great Yogi Berra famously said, “It's tough to make predictions, especially about the future”.

For now, the plan at The Milwaukee Company is to adhere to our rules-based strategies (which utilize dozens of economic and market indicators to adapt our clients’ portfolios to changing conditions and risks) while keeping our guard up. At present, our strategies are generally recommending a bias towards equities, and to shorter term and inflation adjusted bonds, which are less susceptible to rising rates.

Thank you for reading, and my best wishes for a very happy and blessed holiday season!

[1] Most economic data lags by a month or so.