December 2021 | Equity Commentary
Published on January 10th, 2022
Rapidly rising cases of the Omicron variant did not deter U.S. stocks from pushing higher in December. The S&P 500 rose 4.5% with cyclical value stocks outperforming growth for the month. The “reopening trade” that saw value lead in the first four months of the year reversed in mid-May, giving way to growth stocks’ leadership until December. The 10-year U.S. Treasury bond yield moved slightly higher in December but finished the year at a still historically low level of 1.52%. Globally, U.S. stocks were the place to be in 2021—the MSCI USA index posted a return of +27%, which was 19% higher than an MSCI index tracking 49 developed and emerging markets.
U.S. economic growth is expected to be strong for Q4 2021. As of January 4, the Atlanta Federal Reserve’s GDP Now model estimates real GDP growth in the fourth quarter at 7.4%, while Wall Street consensus estimates peg GDP at closer to 6%. The Omicron variant’s impact is likely to be less in the realm of reduced demand in leisure, hospitality, and travel (as in previous waves), and more in supply disruptions linked to people missing work due to sickness. The same general economic takeaway applies now as in previous phases of the pandemic: less growth now likely means more growth later, as demand is delayed but not destroyed.
The number of people filing for unemployment (initial jobless claims) registered at 207,000 for the week ending January 1, close to a 50-year low. Job openings in the U.S. also continue to reach record highs, with an estimated 12 million available jobs by the end of last year, according to job-search site Indeed. These levels imply 1 million new jobs were added in Q4 2021, underscoring the desperation of companies to bring on new workers to meet demand. In December, employers added 199,000 new jobs and the unemployment rate fell to 3.9%. Labor force participation ticked slightly higher but remains below pre-pandemic levels.
The housing market continues to show few signs of cooling, even as the average rate for a 30-year fixed loan has moved from 2.65% a year ago to 3.22% today, according to Freddie Mac. Median existing-home prices rose 13.9% in November from a year ago, in line with trends from previous months. The median sales price for a newly built homes also reached an all-time high. According to the Mortgage Bankers Association, Americans borrowed a record $1.61 trillion to buy homes last year, up from the previous record set in 2020 ($1.48 trillion).
Services and manufacturing PMIs remain firmly in expansion territory, but the Institute of Supply Management said manufacturing activity fell from 61.1 in November to 58.7 in December. The upshot is that the decline was largely influenced by the ‘supplier delivery times’ component of the index. In normal times, falling supplier delivery times implies that demand is waning. Today, it means that bottlenecks are clearing.
There is a good argument that the U.S. economy is experiencing somewhere near peak inflation. Commodity prices may have peaked in October, and supply chain problems started to move in the right direction particularly as Asian factories reopened following pandemic-related lockdowns. Minutes from the Federal Reserve’s December 14-15 meeting, however, make it clear that the Federal Reserve is no longer comfortable waiting for prices to ease: “participants generally noted that…it may become warranted to increase the federal funds rate sooner or at a faster pace than participants had earlier anticipated.” The minutes also noted that some participants see it as “appropriate to begin to reduce the size of the Federal Reserve’s balance sheet relatively soon after beginning to raise the federal funds rate.” Trading in interest rate futures indicates an approximately 70% probability the Federal Reserve would increase the fed funds rate at or before their March meeting, a greatly accelerated timeline from expectations just two months ago.
The Federal Reserve turned more hawkish in Q4. But it is also important to acknowledge their starting point of extraordinary accommodation. In other words, even if the Federal Reserve follows through with ending QE, raising rates three or four times, and shrinking its $8.76 trillion balance sheet over the course of the year, they will still likely finish the year looking quite accommodative by historical standards. The Federal Reserve’s actions in 2022 may be better described as ‘becoming less accommodative’ versus engaging in monetary tightening.
On the political front, the Biden administration’s Build Back Better agenda is stalled. There may be a small near-term impact with the ending of the expanded child tax credit, but it is not likely to significantly alter U.S. households’ overall strong financial position. The bill still has a chance of passing in the coming months in some form but will likely be reduced to a size that would not have meaningful economic impact in 2022. It is also worth noting that the proposed set of tax increases in the original bill have been either removed or considerably scaled down as negotiations continue.