Historically, stocks perform well during the shortened Thanksgiving week. Furthermore, the best day of the shortened week is the abbreviated trading session on the Friday following Thanksgiving Thursday. Well, Mr. Market, as he frequently does, has decided to keep everyone on their toes by changing up the script. Stocks are selling off around the world.
Stocks have poorly performed this week and as we head into the abbreviated Friday session there is nothing but red on my screen. Despite some delicious, albeit too much, Thanksgiving fare, I feel nothing but indigestion as we chew on the news coming out of South Africa about a new COVID variant.
Stock futures have been down more than eight hundred points this morning turning to a 1000+ point rout. Oil is down significantly and not even Bitcoin has been spared from the carnage. It is setting up to be an unusually volatile trading session for this day after Thanksgiving. Thin trading in a shortened session, during a holiday for the world’s largest market is fertile ground for volatility. Add in news about a new COVID variant and you have all the ingredients for a sell off.
While there will be much discussion over the virology of this variant, we are more concerned about the market’s reaction to this news. Will we see stocks take a pause? Will travel bans reappear on the scale we saw last year? Will the Fed change its plan to pull in on the reins of stimulus? These, among other market-related questions, represent what we are focused on answering.
First, we think the news out of South Africa will prove less important for markets than pre-market today’s action suggests. We will leave the science of the variant to the experts. Instead, we will use our expertise on the behavior of investors to predict the market’s reaction. In a shortened trading session, like today, dramatic moves must be taken by investors with a grain of salt.
We do not expect this sell off to gain momentum. Spill over into next week? Yes. However, we are still in a post-pandemic recovery and no variant is going to bring about a crash like COVID did in March of 2020. Investors now have a playbook for a global pandemic, and this will prevent fear from gripping markets in the same way as we saw last year. It is unclear if this latest variant is any more concerning than the Delta variant. It would need to be much worse to keep markets from taking it in stride. Of course, stocks will hit air pockets from time to time, but a fully-fledged crash is unlikely.
Turning our attention to the Fed, we think it is important to spend time thinking through what this might mean for their inflation playbook. Just last week the President re-appointed Chairman Powell to another term. This could prove significant as his competitor for the position, Lael Brainard, was appointed by the President as Vice Chairman. This is important, not because there is significant difference between the two central bankers, but because Brainard is less “hawkish” than the outgoing Vice Chairman, Richard Clarida.
In recent weeks, Clarida has suggested the Fed could speed up tapering and potentially raise interest rates multiple times next year. This position is different than what we have heard from Powell and Brainard. So, we appear to have in place a Chairman and incoming Vice Chairman who are in closer alignment than the current duo as we head into 2022.
If this variant leads to a “clinching” of economic activity around the country and the world, the Fed might be less anxious about inflation than they are now. If so, then a scenario where Fed tapering accelerates, and rates increase earlier, may be off the table. This could support higher stock prices or at least not put downward pressure on them.
It has been our position that the Fed is unlikely to raise interest rates in 2022. Until today, this has been a contrarian viewpoint. After today’s news about the B.1.1 variant, many Wall Street strategists are already altering their opinion on Fed actions.
Our thesis is based on the belief that the current spike in inflation will subside and its trajectory will turn lower as we head into next summer. So, if inflation is trending lower into next summer, this will coincide with the the target of mid summer that the Fed has set for tapering to end.
We think the Fed will want to let the dust settle on the end of tapering before raising interest rates. Furthermore, we think the Fed would prefer to stay out of what is likely to be a contentious mid-term election season. Raising rates, by the Fed, might be used as a political weapon by those running for office. Something that would undermine the Fed’s efforts.
We do not think today’s decline will derail the rally heading into the end of the year. As investors look through the prospect of a new variant, the reality of the recovery will win out. The prospect that the Fed will soften its stance on raising interest rates could provide cover to risk assets like stocks. Having the same Fed chairman in place will also sooth investors who might otherwise fear what a new chairperson would do in response to such an event.
The fear that stocks will sell off before year end, in anticipation of higher taxes next year, will prove unfounded. The theory is that investors will sell stocks with unrealized capital gains to lock in taxes in 2021 instead of subjecting those gains to higher taxes next year and beyond. We think the selloff in stocks will center on those stocks that have unrealized losses. Our thoughts are that investors would rather let their “winners run” and raise cash by harvesting losses in those stocks that have under performed this year.
So, we think the path of least resistance for stocks remains higher into the end of the year. While selloffs will happen along the way, we are constructive on stocks into the new year. Sectors that we think should continue to perform well include industrials, financials, energy, healthcare, and consumer cyclical. Inflation will begin to soften as the Fed embarks on the unwinding of the stimulus it put in place to combat the effects of COVID on the economy.
Kessler Investment Group, LLC
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