As most investors expected, the Federal Open Market Committee announced the start of their tapering effort but doubled the pace of the monthly taper to $30 billion a month until March 2022 when the effort will conclude. In addition, FOMC members see three, 25-basis-point increases in the Fed Funds interest rate next year, and more in 2023.
Faced with the end of a decades-long era of loose monetary policy, historical behavior would indicate interest rates up, equities down. That still seems a good bet despite the market's immediate reaction to the Fed announcement.
Some participants may still be scratching their heads after Wednesday's (Dec. 16) Federal Reserve Bank meeting this week. Normally, an announcement that monetary policy has pivoted to tightening and will likely continue over the next several years would send stocks lower. The opposite happened. Stocks went up. The S&P 500 Index jumped more than 1.5 percent, while the NSDAQ climbed 2.28 percent. The dollar declined, the VIX (the fear Index) dropped below 20 and commodities rallied.
There may be two reasons why the initial reaction to the announcement was contrary to expectations. During Monday, Tuesday, and most of Wednesday, the stock market dropped continuously with the S&P 500 declining by about 100 points. The tech-heavy NASDAQ did even worse. In my opinion, investors went overboard in discounting the Fed's negative news (which was largely already known by the markets). It was a classic "sell the rumor" market play. Jerome Powell and his band of monetary men failed to deliver anything more negative than what was expected, so the signal flipped to "buy the news."
The second explanation might be that despite the Fed's intention to raise interest rates next year, some on Wall Street doubt that will occur, or if it does, at a slower rate than the Fed has telegraphed. Why would that be the case?
There is a growing belief among some in the financial markets (including myself) that the first, and possibly second, quarter of 2022 may not be as strong as many expect. A combination of continued supply chain bottlenecks, higher inflation, and a winter surge in the infection rates of the coronavirus mutations (Delta and Omicron) could combine to slow economic growth.
If so, the Fed may not be willing to add to a slowdown by raising interest rates. It may also call into question how strong corporate earnings and guidance might be. And even of the Fed did try and raise interest rates with that background, the stock market would swoon. That would make the Fed quickly rethink further hikes in my opinion.
You might ask how the Fed's pivot to tightening might impact your investments in the stock market? My initial response is not encouraging. The market's upward response to the FOMC was all about the absence of additional negatives. There was nothing in the statement that was positive for equities. If you have been managing your portfolios on your own, I would advise you to hire good investment adviser — pronto.
The market action during the past few weeks is troubling. Professional investors are deleveraging. They are getting out of high-priced stocks with little or no earnings. Underneath the averages, many stocks are getting clobbered. Defensive stocks such as consumer durables, Real Estate Investment Trusts (REITS), telecom, and health care stocks are getting a bid, while all but the top five or six tech stocks (the FANG stocks) are being sold.
As I said last week, equity strategists are all over the place in their 2022 predictions. What that tells me is that they don't know what is in store for the markets in 2022. As for me, if I just look out to the end of the year (2021), I see continued volatility. Sure, next week we could see the markets bounce, but I have my doubts that we will see a normal end-of-the year Santa Rally.
The VIX still hovers above 20, which means volatility will remain high. Day to day, rotation between sectors seems to be increasing without rhyme or reason. The rally after the Fed announcement on Wednesday was sold down on Thursday with the technology sector erasing all its' gains. The smart money seems to be gravitating towards defensives, or if they are inflation bulls, moving into commodities.
I would be especially cautious as we move into the new year. It would come as no surprise to me if we were to see a substantial pullback. One larger than any we have experienced in 2021. It's time to get an investment adviser.
Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at firstname.lastname@example.org.
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