Authored by :
Michael G. Dow, CAIA, CFA, CPA, Chief Investment Officer
Julien R. Frazzo, Director of Risk Management and Securities Research
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The Quick Facts
- More questions than answers about Omicron, the latest COVID-19 variant
- President Biden selects Jay Powell for a second four-year term as U.S. Federal Reserve (‘Fed’) chair
- Equity markets drop on growing Omicron fears, Powell inflation and taper comments
- Fed Chair Powell admits that it is time to retire the word ‘transitory’ for inflation
- Powell indicates that taper could end a few months sooner
- VIX sees its largest monthly surge since February 2020
- Growth strongly outperforms value in November
November proved to be a volatile month for most asset classes. The S&P 500 dropped 0.7% while the Nasdaq Composite rose 0.3%. Hawkish comments from Fed Chair Powell and uncertainty over the new Omicron variant weighed on the markets to end November. Despite the recent decline, the S&P 500 remained up 23.2% year-to-date (YTD). All the major indexes made new highs during the month but could not hold on to those gains.
There are many more questions about Omicron than answers as we go to print. Some variants that were initially feared to be a concern have faded from memory without causing widespread harm. Others, such as Delta, have caused damaging new waves of the pandemic. Doctors in South Africa, where the Omicron variant first emerged, have said that the symptoms so far have been mild and pharmaceutical companies have suggested that vaccines could be adapted quickly, if necessary. We are unlikely to have a good picture on the Omicron variant for several weeks, but we can rely on a few lessons from the past. The first lesson, from Delta, is that it is very hard to stop the spread of virulent new variants. The second point is that what causes the bulk of the economic damage are the government restrictions imposed in response to the virus (and rise in hospitalizations), not the virus itself. How governments around the world respond as Omicron spreads will be key. In the U.S., President Biden is expected to unveil a new Covid-19 federal strategy that will deal with the virus “not with shutdowns or lockdowns, but with more widespread vaccinations, boosters, testing and more.” The final point to make is that the global macro backdrop is very different now than in previous waves of the virus. Supply chains are already stretched. A major new wave could be inflationary.
November Asset Class Performance
On November 22, President Biden selected Jay Powell for a second four-year term as the Fed Chair and elevated Governor Lael Brainard to Vice Chair, maintaining consistency at the central bank as it grapples with the highest inflation in three decades and the lingering effects of the Coronavirus pandemic. The Omicron variant further complicates a complex monetary policy challenge: the balance between full employment and keeping inflation within the Fed mandate. The Fed is currently scheduled to complete its asset-purchase program in mid-2022 under a plan announced at the start of November to slow buying by $15 billion a month. The next gathering of the policy-setting Federal Open Market Committee (FOMC) is on December 14-15, when the Fed could decide to accelerate the tapering. On the economic front, U.S. consumer confidence slid to a nine-month low in November as a pickup in Covid-19 cases and accelerating inflation weighed on Americans’ views about the economy.
The Russell 2000 (an index of small-cap companies) made a new all-time high on November 8 only to see those gains washed away, closing lower by 4.2% for the month. The yield on the benchmark 10-year Treasury saw a sharp decrease to end November at 1.45%, after starting the month at 1.55% and peaking at 1.67%. Growth massively outperformed value in November. The Russell 1000 Growth is now up 24.9% YTD, 7.2% ahead of the Russell 1000 Value. International markets continue to underperform with the MSCI EAFE (Europe, Australasia and the Far East) up 6.4% YTD and the China-heavy MSCI Emerging Markets now down 4.3% YTD.
Technology was the clear winner of the eleven Global Industry Classification Standard (GICS) sectors in November with a 4.5% return followed by consumer discretionary at +1.6%. The remaining nine sectors were down for the month with Communication Services (-6.1%), Financials (-5.7%) and Energy (-5.0%) as the worst-performing sectors.
Persistent levels of elevated inflation and a seemingly more hawkish Fed are accelerating the recent U.S. dollar rally. The U.S. Dollar Index, (indicating the general international value of the USD), was up 2.0% in November. Oil prices (West Texas Intermediate, or WTI) saw a double-digit pullback of 19%. Oil prices fell in November but are still trading near multi-year highs after topping out at nearly $85 a barrel.
Gold was mostly unchanged for the month at $1,772/oz. Gold remains one of the worst performing asset classes in 2021, with a –0.5% YTD return. Bitcoin made a new all-time high in early November (topping $68,000) before the “risk-off” mood took the most popular cryptocurrency lower. Bitcoin declined 6.3% for the month but remains up close to 100% YTD at $57,159.
Volatility returned to the markets as the CBOE Volatility Index or VIX saw its largest monthly surge since February 2020, increasing over 68% in November from a low of 14.8 to a high of 29.0 on the day after Thanksgiving.
Investment Summary – “Inflation, Rates, and Rotation” in an Era of Financial Repression
At Beacon Pointe, we remain “risk-on” (less so versus 3Q2021) given positive vaccine developments, 3Q corporate earnings surprises, reduced risk of a major tax rate hike, and favorable seasonality. We cannot ignore the massive monetary and fiscal support expected now and, in the future, but “stagflation-lite” is a growing concern on a cyclical basis. We prefer Equity and Alternatives to “safe” Fixed Income given the current and expected negative real yield environment. We are adding to our positions that reflect a rotation from U.S. Large Cap Growth to U.S. Large Cap Value, U.S. Small Cap, and EAFE (growth) given economic reflation. We are reducing the allocation to Emerging Markets (EM) equities given our less than optimistic views on China and other EMs. We are increasing the position slightly in short-term bonds to protect portfolios from rising interest rates. We retain the inflation protection position in TIPs but are reducing Real Assets (Gold) while increasing the exposure to Hedge Funds.
Chart of the Month – Real Monthly U.S. Equity Returns by Inflation Regime
Inflation has dominated the headlines in 2021. Whether the current higher readings are transitory or structural, how can investors hedge against inflation risk? According to a recent survey of institutional investors at a bank conference, 47% of respondents believe commodities are the most effective security against inflation, followed by equities (27%), rate products and Treasury inflation-protected securities (TIPS, 10%). Are equities an inflation hedge? Historically, the answer is yes. In real terms, inflation over 5% sharply reduced returns but real returns were still positive with inflation above 10%; therefore, equities did hedge against inflation. Nevertheless, stocks are volatile instruments, and the average return conceals the dramatic drawdowns that occurred over the 1970s.
Major Asset Class Dashboard
Important Disclosure: This report is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. All investments involve risks, including the loss of principal. Investors should consult with thier financial professional before making any investment decisions. Past performance is not a guarantee of future results.
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