The small gains made through mid-November were overtaken by a downward trend to end the month. During the final three trading days of November, news of a new COVID-19 variant, dubbed “Omicron”, spurred a 2.9% drop in global markets. Long-term interest rates fell as well. As measured by the MSCI All Country World Index, global equity markets ended down 2.4% for the full month of November.
While it would be easy to attribute all of November’s weak stock market performance to fear of the Omicron variant, the markets began to soften at least a week prior. This was especially evident in U.S. small-cap stocks, which were up more than 6% after just one week, before reversing course and ending the month down 4.2%. One possible explanation for this weakness is inflationary concerns, which were dominating the financial headlines prior to the appearance of the Omicron variant.
After over a decade of benign inflation, a combination of supply chain disruptions and stimulus-fueled demand has increased annual inflation rates to approximately three times higher than pre-pandemic levels. Initially, as inflation rates rose, Federal Reserve officials and many economists expected pricing pressures to naturally ease as production bottlenecks worked themselves out and more people rejoined the workforce. Instead, inflation has stayed elevated, so much so that Fed officials have been forced to admit inflationary pressures will likely be here well into 2022. Some Fed officials have even called for a faster reduction in their security purchases as part of their quantitative easing program, both to reduce inflation and to prepare the central bank’s position for rate hikes.
Investors now expect that interest rate hikes will happen by early next summer, with predictions for a total of two or three hikes during 2022. This is a dramatic turn of events, since not long ago the common sentiment was that the first policy rate hike wouldn’t occur until 2023. Fortunately, inflation and the possibility of rate hikes has long factored into the way we approach bond investing. Elevated inflation has made our allocation to Treasury Inflation-Protected Securities (TIPS) perform well. Year-to-date, TIPS have outperformed the overall bond market by over 6%. To hedge against sooner rather than later interest rate increases, we remain focused on short-term and intermediate-term bonds.
As always, perspective remains crucial to investment success. Despite November’s volatility, the markets remained relatively sturdy. Even with the COVID-19 variant concerns, markets have still not experienced a correction of 10-15% at any point this year. In fact, the worst decline in the U.S. stock market this year has only been about 5% which – by any normal standard – is minor. The economy, too, continues to show signs of strength with low unemployment, strong GDP growth, and lots of companies beating their Q3 earnings expectations. These are all reasons to keep a long-term perspective heading into 2022.
Speaking of perspective, as we make our way into December, we find ourselves giving thanks. We are thankful for our clients, our team, and our families. We wish you wonderful holidays, filled with the warmth of the season. Stay well, and please reach out if we can be of service. As always, we are here for you.