December Volatility and Sector Rotation as the Fed Tapers Faster


The S&P 500 closed lower on Friday to end what was a volatile week.  The S&P 500 index fell 1.9% last week as worries about the Federal Reserve, inflation and Omicron/COVID-19 weighed on risk sentiment.

The market benchmark ended the week at 4,620, down from last Fridays closing level of 4,712. Before this Monday mornings sell-off, the index was positive for the month, up 1.2% for December to date. Positive seasonality of December, is historically back-end loaded with the first half of December being volatile and net flat during the first 10-15 trading days of the month.  That is to say, the “Santa Clause rally”, if it arrives, statistically speaking, is more likely to show in the markets through the 2nd half of December into early January.

Omicron and a Shift in White House Messaging

The Omicron variant is beginning to surge throughout the U.S., which has been expected for some time. In South Africa, the Omicron surge lasted about 25 days and then began to rollover, which suggests a US peak for the Omicron variant in January. More interestingly, the White House has indicated a shift away from “number of cases” and prior language of “freedom from Covid,” to “severity” and a “learning to live with the virus” in relation to their approach and messaging. This is a stark change, and more akin to the endemic view of the COVID virus, which many scientists have been promoting for some time.

Sector Rotation in the Markets

There is a lot of rotational action and bifurcation occurring under the markets.  Health care, real estate, utilities, and the consumer staples (“boring sectors”) all finished slightly higher for the week. The materials sector fell, and the drops were even worse in financials, communication services, industrials, tech, consumer discretionary, and energy. These are typical rotations when the yield curve flattens, which is has been since late 1st quarter 2021.

The energy sector had the largest percentage drop of the week, down 5.1%, followed by a 4.3% slide in consumer discretionary and a 4% decline in technology. Four sectors rose. The health care sector posted a 2.5% increase, followed by gains of more than 1% each in real estate, utilities and consumer staples.  The various ups and downs of different sectors and groups is part of the reason a diversified portfolio remains a fundamental element of a long-term investing strategy.

Tightening and the Stock Market

Our view is that unless there is a huge Federal Reserve mistake, early-cycle tightening is rarely bad for stocks over time. This is normally the case because such tightening is set against an expanding economy and earnings.  That looks to be true in today’s environment. Extreme levels of demand are driving a significant portion of the pickup in inflation that we have seen.

While the market believes the Fed will raise rates three times, and this has been priced into the bond market already, our current view is that “two hikes and done” before the mid-term elections for 2022 is a more likely outcome.

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