Following a brutal week of trading, stocks opened higher this morning before rising even further through noon. Dow components led the way, dragging the S&P upward while the Nasdaq Composite lagged.
Our commentary last week noted that the Covid Omicron variant may not be worth worrying about. Today, investors seemed to realize that. It’s true that the new variant is more infectious, but early cases have suggested that it produces far milder symptoms than other Covid strains. Because of this, Omicron could potentially crowd out Delta, leading to a less-lethal version of Covid.
Some analysts believe, however, last week’s losses had little to do with Covid headlines.
“Super-cap tech has been well bid on the expectation of ‘forever’ low rates and support,” said Sevens Report founder Tom Essaye.
“But, with the prospect of rates rising and this new Fed paradigm, we are seeing investors rotate out of tech and into sectors with better exposure to higher growth.”
Essaye continued, adding that the Fed’s recent remarks on inflation and the ongoing taper ultimately dented sentiment.
“Tech pulled the entire market lower. Essentially, we are seeing a sort of Taper Tantrum 2.0 as markets react to a more hawkish Fed and rotate into sectors with more positive exposure to rising rates.”
As of this morning, the tantrum seems to have calmed somewhat. But that doesn’t mean the bull market is back on just yet. The S&P, for example, still lingers near key support at 4,550. A failure to rebound off support over the next few trading sessions could doom the market to a deeper retracement, especially if rate hike expectations continue to rise.
“Any speculative growth portions of the market are the ones that are trading off the most and that’s perhaps due to accelerated Fed tapering and Fed rate increases,” said US Bank Wealth Management’s Tim Hainlin.
“If you raise interest rates that decreases the value of those long-term cash flows for those long-term growth companies or parts of the market that are dependent on them.”
But Hainlin believes that investors have gone overboard with pricing in a more aggressive rate hike next year.
“The long-term growth rate is challenged by factors that are changing — demographics, productivity and longer-term growth in the labor force — and drive the economy in the long-term,” he explained.
“We still think those are muted relative to history, so the idea that the Federal Reserve would raise rates up until up to a rate that we’ve historically seen — we think that it’s not likely to get up to that level.”
What Hainlin didn’t mention, though, was how “hot” inflation has gotten in recent months. Persistently higher inflation, not strong economic growth, caused Fed Chairman Jerome Powell to consider accelerating the Fed’s taper.
In addition, the Federal Open Market Committee (FOMC) is now clearly concerned that stagflation – low consumer demand, high inflation – could soon arrive. The FOMC will meet later this month (December 15th) to discuss monetary policy moving forward.
If traders get any indication that the FOMC is tilting hawkish, expect stocks to drop again, regardless of how the Omicron situation looks in the coming weeks.
