Two items increased stock market volatility at the end of November – the emergence of the omicron variant of covid and the Fed’s acknowledgement that inflation pressures will remain in place longer than anticipated. As a result, Fed Chairman Jerome Powell said the central bank would consider winding down its easy-money policies and unprecedented monetary stimulus more quickly in an effort to curtail inflation.
It will be some time before investors even have enough information to judge how big a threat the new omicron variant is and how governments, businesses and consumers respond to it. Renewed restrictions in the U.S. and elsewhere would have an immediate negative impact on the economy. If other countries impose restrictions in response to outbreaks that could exacerbate many of the supply-chain problems that companies have been facing.
A significant positive is that the technology used to produce the current vaccines in record time can be quickly modified to address new variants. Vaccine makers say if it proves necessary, they can quickly develop modified boosters that will work against omicron, with Pfizer Chief Executive Albert Bourla saying his company can create one in fewer than 100 days.
Likely a longer impact on the market is the Federal Reserve indicating that it might speed up the reductions, or tapering, of its asset purchases, with Fed Chairman Powell saying Tuesday the central bank should consider doing so. For months, the Fed has labeled inflationary pressures as transient. Powell said inflation will now remain elevated at least through mid-2022, and the word transient is no longer appropriate. The Fed has said it would end asset purchases before raising interest rates, so this announcement potentially signals an earlier increase in rates.
Despite these uncertainties, the economy remains quite strong currently. The ratio of the coincident to leading economic indicators, a fairly reliable predictor of pending economic weakness, remains very positive. Both consumer spending and business spending are robust.
S&P 500 revenues and earnings are at an all-time high and third quarter stock buybacks and dividends hit a quarterly record as companies returned a significant portion of their strong cash flow to their shareholders.
Earnings over the next 1-2 years will be solid, but sustained inflation means the price investors pay for each dollar of earnings will be lower. How that tug-of-war between rising earnings and falling valuations plays out will ultimately determine the returns for the stock market. Many stocks are not cheap. Having a long-term plan, sticking with your asset allocation, owning quality companies and not overpaying for them are the hallmarks of prudent investing.
All of us at LVM extend our best wishes to you and your loved ones for a happy and blessed holiday season!