Stocks tumble on Omicron fears, shift in Fed policy

Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell. – Warren Buffett

The worrisome spread of the Omicron variant of Covid-19 and the prospect of tighter monetary policy by the Federal Reserve were too much for the stock market to overcome last week as the S&P 500 Index declined nearly 2%. The Nasdaq Composite Index, which is dominated by technology stocks that in many cases have become overvalued, fared even worse and plunged 3%. Despite an announcement from drug manufacturer Pfizer that its drug aimed at treating patients with the virus proved effective in final testing against the fast-spreading Omicron variant, fears rose about how easily it spreads and what effect that may have on the economy. Making matters worse was a decision by the Fed at their Federal Open Market Committee (FOMC) meeting to accelerate the reduction in its monthly bond purchases, effectively ending it in early spring of next year when the Fed would then begin to raise the federal funds rate. Fed officials now forecast that there will be three interest rate hikes in 2022 designed to combat high inflation, which has been caused by supply and demand imbalances due to the pandemic and the reopening of the economy. Not only did the Federal Reserve raise its inflation outlook for both this year and next, but it also reduced its outlook for GDP growth in 2021 and cited the Omicron variant as a risk to future growth. The decision by the Fed to become less accommodative came on the heels of the November producer price index (PPI) last week, which rose 9.6% from a year ago, the highest level since November 2010 and much higher than expected. Although the core PPI, which excludes volatile food and energy prices, was slightly less than forecast, it has risen nearly 7% year-over-year and has been running at the highest level in about 30 years. The yield on the 10-year Treasury, however, dropped to 1.40% on Friday, as investors sought a safe haven in the midst of stock market turbulence and concluded that the Omicron variant could have a negative effect on the economy.

Last Week

Other economic data released last week was mixed as November retail sales rose modestly and were less than expected while November housing starts were well-above estimates. Weekly jobless claims were 206,000, above the estimate of 195,000, and industrial production in November rose modestly after a huge increase in October.

For the week, the Dow Jones Industrial Average fell 1.7% to close at 35,365 while the S&P 500 Index dropped 1.9% to close at 4,620. The Nasdaq Composite Index lost 3.0% to close at 15,169.

This Week

The third and final estimate for third quarter gross domestic product (GDP) is expected to be 2.1% and November leading economic indicators are forecast to rise modestly but less than in October with projections of 5% growth in GDP in the fourth quarter. Both November existing home sales and new home sales are expected to be higher than in October and November durable goods orders are expected to rebound strongly after declining last month. The consumer confidence index for December is expected to be the same as in November and much lower than the peak in June due to concerns over rising inflation and the spread of Covid-19 variants.

Both the stock market and the bond market will be closed on Friday in observance of Christmas.

Among the most notable companies scheduled to report quarterly earnings this week are Micron Technology, Nike, General Mills, CarMax, Cintas, Paychex and Rite Aid.

Portfolio Strategy

With core inflation running at the highest level in 30 years and bond yields at historically low levels, investors in search of additional income and protection from inflation could benefit from real estate investment trusts or REITs. REITs are companies that own or operate real properties such as office buildings, apartment buildings, storage facilities, shopping centers, hotels and health care facilities and are required to pay out 90% of their taxable income to shareholders in the form of dividends. While they typically carry more risk than either Treasury notes or corporate bonds, they do make dividend payments monthly or quarterly and are able to increase rents when prices are rising. The current yield on the 10-year Treasury is only 1.40% and with the Federal Reserve likely to raise interest rates next year, bond yields will probably rise and the value of fixed income investments will almost certainly decline. (Bond yields and prices move in opposite directions). One of the best investment vehicles to gain exposure to REITs is the Vanguard REIT ETF (VNQ), which tracks the performance of the MSCI U.S. REIT Index. This year REITs have been the second best performing sector of the market behind the energy sector with a year-to-date total return of 34.2% through the close of business on Friday. Despite this strong performance, REITs should continue to do well as rents and property values tend to increase as prices go up, which means larger dividend payments for shareholders. The current yield of the Vanguard REIT ETF is about 3% and REITs also diversify the risk of holding stocks and bonds in a portfolio.