What I Care About This Week | 2021 Dec 27

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by Franklin J. Parker, CFA

This week’s market update is somewhat abbreviated due to the Christmas and New Year’s holidays.

The Summary

  • Personal consumption expenditures posted the highest year-over-year growth since 1982, coming in at 5.7% in November (see chart below). PCE is an alternate measure of inflation as it reflects what consumers are actually spending at the store, not bound by the specific basket of goods that makes up the consumer price index (official inflation). The Fed looks closely at PCE, as do investors, for a gauge of spending “in the wild.” Such a strong figure puts additional pressure on central banks to reel back the excess cash pushed into the economy over the past couple of years.

  • Equity markets have taken omicron and the threat of central bank tightening in stride, but I am not too surprised by this. Again, my view as been that markets will not start taking rate hikes seriously until February/March of next year. What has surprised me is the complete non-reaction in rate markets. Despite higher inflation, slower purchases from the central bank, and the threat of higher rates next year, US Treasury yields have remained largely unmoved. Admittedly, it is hard for risk-aware capital to push prices given the amount of risk-unaware capital floating around. Still, I do believe that the dam will break sometime, and when yields begin to march higher, investors may do well to be out of the way.

  • Today, the S&P 500 appears poised to log its 69th record close for the year. Yet there is a disconnect: the top 5 stocks in the index have delivered over a third of the return for 2021 (see chart below). After a strong rally early in the year, small caps have traded sideways for most of the rest of the year. And since August, defensive sectors have generally outperformed. The point is, there is an argument to be made that this market is building toward a correction—an argument that is furthered by my read of the macroeconomic fundamentals. Again, my suggestion is to consider growing more defensive with and/or adding some risk controls to portfolios after Q4 earnings season. In the end, your goals will dictate the risks you can afford to take.

Some Charts

Our first chart is that of personal consumption expenditures, and how they have gown year-over-year. November’s spike is a genuine concern as it continues the trend from October. Investors will watch December figures quite closely.

Our next chart is curtesy of Goldman Sachs which shows that over a third of the S&P 500’s 2021 return has come from just five companies: MSFT, AAPL, GOOGL, TSLA, and NVDA. The remaining 495 companies are responsible for the other 65% of returns. It is this divergence that worries some analysts. A more inclusive rally would typically be indicative of a healthier market and economy.

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With the Federal Reserve removing support from markets and inflation heating up, many are wondering if a correction is looming. Download our 2022 Outlook for our insights on what is next.
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