Markets have become increasingly choppy over the last two weeks. Despite the S&P 500 sitting less than 4% below an all-time high, a string of large intra-day swings has put some participants on guard. Noisy stock prices can largely be attributed to yet another strain of Covid. The Omicron variant is quickly spreading across the globe and renewing concerns about the durability of the economic recovery. Complicating matters, the Fed and other central banks are dealing with rising pressure to take on inflation. Prices continue to rise at a sharp pace, and the Fed may soon be forced to speed up its tapering program. Taming inflation without slowing economic growth is a difficult task. Another wave of Covid only adds to the uncertainty. Participants are struggling with the lack of visibility into 2022.
As of Friday, the Omicron variant had been found in 38 countries around the world and 5 US states. Early data suggests that symptoms have generally been mild but that this strain may be more transmissible. The good news is that deaths are not rising at the same pace as cases. The lethality of the virus appears to be waning as vaccination, natural immunity, and new therapies become commonplace. So far, the US has shown reluctance to reenter a state of lockdown, but the rest of the world has already become more restrictive. There is growing lockdown fatigue, and widespread restrictions are not likely to be politically expedient for long. There is certainly an element of learning to live with the virus. Still, any disruption in global economic activity could prove challenging. This is particularly true as global supply chains try to resync and work through inflationary bottlenecks.
The bond market is also showcasing its concern for the path of economic growth. 10-year treasury yields are breaking to their lowest level in months despite the ongoing pressure from inflation. A flatter yield curve is indicative of lower expectations for future economic growth. In this instance, the bond market is likely saying that the Fed will have a difficult time reigning in inflation without slowing the economic recovery. This is meaningful for equities because the relative performance of growth stocks and value stocks has largely been dependent on the direction of treasury yields for much of the year. This relationship could influence sector positioning across our strategies as we move into the new year.
Though the path ahead may be less certain, we are not bearish on equities. We continue to live in a low-interest rate world where the earnings yield on equities far exceeds the yield available on most bonds. With most stocks trading at attractive valuations relative to alternatives, we continue to believe that money will come off the sidelines and into stocks during these periodic pullbacks. Investors reluctant to get into stocks when the index is making an all-time high may be more enticed at these levels. The average stock is down over 13% from its high. This sits against the backdrop of corporate earnings that have consistently defied expectations for much of the last two years. S&P 500 earnings are currently projected to grow around 5% in 2022. We think that companies will be able to continue driving solid bottom-line growth through rising productivity levels. In combination with TINA (There Is No Alternative), we think equities have room to run.
Preston May, CBE®
This report was prepared by Donaldson Capital Management, LLC, a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Information in these materials are from sources Donaldson Capital Management, LLC deems reliable, however we do not attest to their accuracy.
An index is a portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance to certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Past performance is not a guarantee of future results. The mention of specific securities and sectors illustrates the application of our investment approach only and is not to be considered a recommendation by Donaldson Capital Management, LLC.
S&P 500: Standard & Poor’s (S&P) 500 Index. The S&P 500 Index is an unmanaged, capitalization-weighted index designed to measure the performance of the broad U.S. economy through changes in the aggregate market value of 500 stocks representing all major industries.