November 2021 Market Commentary
A tale of two halves. Don’t count your chickens before they hatch. It’s not over until it’s over. Pick whatever analogy you want, the market narrative that prevailed for most of November was nothing like the one at the end of the month. Prior to Thanksgiving, a relative calm had asserted itself over the markets. Yes, investors were nervous about supply chains, inflation, and monetary policy, but for the most part they appeared to be taking a wait-and see approach with respect to how those issues would unfold. Besides, there were a number of positive catalysts to consider. Third-quarter earnings concluded with aggregate S&P 500 earnings increasing 39%. Congress passed a $1.0T infrastructure bill. Consumer spending surprised the upside. Unemployment reached a new recovery low. Fed Chair Jay Powell was nominated to another term, providing stability to monetary policy. Supply chain issues appeared to be improving, if only incrementally. Coronavirus concerns were waning. The positive backdrop was reflected in market performance with the S&P 500 up just over 2.0%.
The calm was shattered, however, by news on Thanksgiving Day that a new highly mutated coronavirus variant had been discovered. In response, the World Health Organization (WHO) convened an emergency meeting at which the variant was named Omicron and labeled a “variant of concern”, the same designation previously assigned to the Delta variant. While much remains to be learned, scientists are concerned about Omicron’s large number of mutations, some of which may confer an advantage with respect to transmissibility, or the ability to evade current vaccines. With so much uncertainty about the virus and its potential impact on the current recovery, investors took a sell first, ask questions later approach the day after Thanksgiving. That resulted in the S&P 500 falling 2.3%, its largest daily decline since February. Oil fell 13%, its largest decline since April 2020. At the same time, reflecting demand for safe-haven assets, the 10-Year Treasury yield fell 0.16%, its largest daily decline since March 2020. Market volatility remained elevated during the last two days of the month, with the S&P 500 rebounding 1.3% on Monday, November 29, before falling again on Tuesday, November 30, losing another 1.9%.
As a result of the Omicron-induced selloff, November equity market returns were negative across the board. Large caps (S&P 500) fell -0.8%. Small caps (Russell 2000) fell 4.3%. International markets suffered similar losses with developed (MSCI EAFE) and emerging (MSCI EM) markets shedding 4.8% and 4.1%, respectively.
So what now? In the near-term, market volatility will likely remain elevated as scientists race to better understand the characteristics of the new variant, and most importantly the efficacy of current vaccines to prevent, or at least minimize, its spread. Until those questions are more adequately answered, markets will remain susceptible to overreacting, both up and down, to the news of the day. For investors, the challenge will be determining Omicron’s potential impact on the current economic recovery. In the US, any economic impact will likely result from the collective actions of individual consumers deciding to alter their behaviors. The likelihood of a nationwide shutdown is remote with President Biden having already ruled out the possibility. A relatively high vaccination rate should also help blunt the worst of Omicron’s impact.
In other countries, however, the impact might be quite different. As seen earlier this year, some countries such as Vietnam and China, which play important roles in global supply chains, are prepared to take drastic measures to limit the spread of COVID. As an example, in August, China closed one of five shipping terminals at the world’s third-largest port for two weeks due to a single reported case of coronavirus. Similar actions, if repeated in response to Omicron, would no doubt exacerbate current supply chain challenges. More recently, in Europe, Austria announced a new nationwide lockdown in an effort to contain a surge in Delta variant cases. Germany, facing its own surge, said it might be forced to take similar measures. Additionally, the ongoing disparity in vaccination rates between high-income and low-income countries will continue to hamper a global synchronous economic recovery.
In many respects, the bond market’s experience in November was the inverse of equity markets. For much of the month investors sold bonds on concerns about surging inflation. In response, the 10-Year Treasury yield rose from 1.55% to 1.67%, just seven basis points (0.07%) shy of its high watermark for the year. As a result, by Thanksgiving, the Bloomberg US Aggregate Bond Index, the broadest measure of the US bond market, had fallen 0.6%. However, in response to the post-Thanksgiving Omicron-induced equity market selloff, the Agg rose 0.9% in the final three days of the month, the largest such move since March 2020. For the month, the Agg returned 0.3%. US Treasuries, reflecting their safe haven status, returned 0.9%. Similar to Treasuries, municipal bonds returned 0.8%. Investment grade corporates were effectively flat, returning 0.1%. High-yield corporates were the worst performing sector falling 1.4%, reflecting their greater correlation to equity markets.
Should the economic impact of Omicron prove to be relatively benign, the bond market will quickly refocus its attention on inflation and monetary policy, its primary concerns before Thanksgiving. By any measure, inflation is well above the Fed’s longer-term target of 2%. In November, the three primary measures of inflation- consumer prices (CPI), producer prices (PPI) and personal consumption expenditures (PCE), the Fed’s preferred measure- all reached their highest levels since the early 1990s, up 4.6%, 6.2%, and 4.1%, respectively, from the prior year. In response to rising prices and in acknowledgement of the economy’s overall improvement, the Fed officially announced the start of its tapering plans in early November. The plan calls for the Fed to reduce its bond purchases by $15B/month, concluding the program by mid 2022. Thereafter, pressure will build on the Fed to begin raising interest rates. Prior to Thanksgiving, market expectations had risen to three rate hikes before the end of 2022.
Shortly before Thanksgiving, President Biden nominated Jay Powell to serve another term as Fed Chair. Powell’s re-nomination was seen as an effort to maintain continuity of monetary policy during these turbulent times. The news pushed yields higher as markets had begun pricing in the possibility of President Biden nominating current Fed Governor Lael Brainard to the post. Brainard is generally viewed as being more “dovish” than Powell and thus it was thought she might be less aggressive than Powell in tightening monetary policy.