The better-than-expected third-quarter corporate earnings reports were evidence of a broad-based economic recovery causing investor psychology to improve and funds to flow from bonds into stocks. This has since reversed as the uncertainty of the spread and severity of COVID mutation Omicron remains unknown. The concern is that the supply chain of parts and goods produced in emerging markets may slow and deter global economic growth.
The better news is that people are returning to work, container ships are unloading, truck and train traffic is increasing, and stores are preparing for an active holiday shopping season. Economic activity is strengthening and will be augmented over the next five years with the government’s $1-trillion real infrastructure investment plan. The expectation is that this government spending will improve roads, bridges, tunnels, rail systems, electric charging stations, and even internet connectivity, which will all enhance productivity in the U.S.
The fixed income market is contending with a relatively flat yield curve offering a two-year U.S. Treasury rate of 0.52% and the 10-year at 1.43%. The spread between the two is monitored closely, with investors divided in their assumptions about interest rates. Some believe inflation is temporary and that the continuing virus spread will slow the economy. Others believe inflation will be more prevalent, causing the curve to steepen with longer rates rising quickest. Federal Reserve Board Chairman Jerome Powell said this week that inflation is not transitory but persistent, which elevated the probability that bond purchase tapering and interest rate increases may be accelerated. He described the economy as strong and said that policy will adapt to the economic indicators in the future. Omicron will most likely not slow commerce in the U.S. dramatically and a rising rate environment is evidence of a growing and dynamic cyclical recovery rather than an end of economic growth.
Most financial, industrial, information technology, and energy sector companies reported solid earnings, which has lifted expectations for the year ahead. Small-cap companies were leading the market higher this year, but recent volatility means the large cap growth technology names are acting more like defensive stocks and performing better. In the past 70 years, the December returns for the S&P 500 Index have been positive 74% of the time, and the small cap effect (outperformance) usually starts in the middle of the month.
The recent Initial Public Offerings of EV (electric vehicle) car makers like Rivian and Lucid, which have not made many cars nor offer opportunities for profits anytime soon, demonstrate the speculative fever in fast-growing, disruptive companies. There is concern that Bitcoin, Non-Fungible Tokens, SPACs (Special Purpose Acquisition Companies), cannabis and meme stocks are demonstrative of massive retail speculation in the markets. These are certainly investments to avoid. We are maintaining our quality standards for portfolio investments and believe the strengthening economy will be driven by technology, industrial, and energy sector companies.
Index Year-to-date return
S&P 500 Index.................................21.6%
S&P Small Cap 600 Index..............22.6%
MSCI AWCI International Index....14.2%
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