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Omicron variant and Fed comments spook markets, stocks fall

The stock market goes up or down and you can’t adjust your portfolio based on the whims of the market, so you have to have a strategy in a position and stay true to that strategy and not pay attention to noise that could surround any particular investment. – John Paulson

The weakness in stocks that began on Black Friday with the discovery of the Omicron variant of Covid-19 in South Africa continued last week as the major stock averages all suffered losses as the first case appeared in California and has now spread to other states as well. For the second week in a row, the technology-laden Nasdaq Composite Index was the biggest loser as large cap, expensive growth stocks took the brunt of the selling. While it doesn’t appear that the Omicron variant will have a meaningful impact on the global economy, right now there are more questions than answers and that creates a lot of uncertainty for investors. What we do know is that this variant seems to be more transmissible than the Delta variant but, at the same time, its symptoms seem to be very mild, especially for people that have been vaccinated. But the CEO of Moderna said last week that he expects vaccines to be less effective against the new variant and it could take months to develop an Omicron-specific vaccine. The potential spread of the new variant wasn’t the only reason that the stock market fell last week. In his testimony before Congress, Federal Reserve Chairman Jerome Powell said that the Fed will accelerate its bond-buying taper beginning this month and will complete the taper of the asset purchases much sooner, probably by next spring. With the economy much stronger and inflationary pressures higher, Powell realized that inflation can no longer be described as ‘transitory’. The Fed’s focus now is to combat inflation even though the economy could be negatively affected by the spread of the new Omicron variant. This shift opens up the possibility that the Fed may also raise interest rates in the spring. The uncertainties associated with rising cases of the virus and a less accommodative Federal Reserve could lead to a more volatile market, but we should be able to weather the storm as we have done with the Delta variant.

Last Week

The November employment report was disappointing as it showed that only 210,000 new jobs were created, well below the 525,000 that were expected, but the unemployment rate fell to 4.2% compared to expectations of 4.5%. The labor participation rate also increased and suggested that the labor market still appears to be strong. ADP reported that private payroll data showed that 534,000 jobs were added in November, which was better than forecast, and weekly jobless claims were 222,000, lower than the estimate of 240,000. The November ISM manufacturing index matched expectations and was solidly in expansion territory while the ISM non-manufacturing or services sector index was at the highest level since the data began to be measured back in 1997. The services sector accounts for more than two-thirds of U.S. economic activity. The consumer confidence index for November fell to a 9-month low on inflation and Covid worries.

For the week, the Dow Jones Industrial Average fell 0.9% to close at 34,580 while the S&P 500 Index declined 1.2% to close at 4,538. The Nasdaq Composite Index dropped 2.6% to close at 15,085.

This Week

The core consumer price index (CPI) for November, which excludes prices for food and energy because they are so volatile, is expected to increase slightly less than 5% year-over-year. Unfortunately, the inflation number is expected to be even higher than in October, which was the highest that the CPI has been in 30 years. The University of Michigan consumer sentiment index for December is forecast to be slightly less than it was in November due primarily to inflation concerns and the new variant.

Among the most notable companies scheduled to report quarterly earnings this week are Costco Wholesale, Campbell Soup, Casey’s General Stores, AutoZone, Toll Brothers, GameStop, Ciena and Broadcom.

Portfolio Strategy

With third quarter earnings season slowing to a trickle and a paucity of economic data this week, the market will continue to process Federal Reserve Chairman Jerome Powell’s comments and follow the developments related to the Covid Omicron variant. There is one economic report due out Friday that will be significant, though, and that is the November consumer price index (CPI). Inflation has been running much hotter than it has in decades and the reading is expected to be even worse than it was in October. This persistent high inflation is why Powell acknowledged last week that he was wrong about inflation being ‘transitory’. The fact that the Fed will now speed up the taper of its $120 billion monthly bond-buying program also means that interest rate hikes could come sooner than originally expected. The Federal Reserve implemented the bond-buying program in early 2020 in order to boost the economy during the onset of the pandemic. But in addition to this real possibility, the market must also weigh the negative effects of the new variant, which could exacerbate existing supply chain problems and cause even higher inflation. Normally, such a scenario would lead to higher bond yields (bond prices and yields are inversely related), but the yield on the 10-year Treasury fell to 1.35% last week as investors sought safety in government securities. Until there is clarity on the omicron variant in terms of its possible threat to disrupt the economy, the market is likely to remain volatile. Fear and greed can drive markets and right now fear of the unknown associated with the variant and inflation has its grip on investors. Those investors that are patient, however, should be rewarded if these Covid Omicron fears prove to be unfounded and the economy and corporate profits are not negatively impacted.