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November 30, 2021
As we round out 2021, we have now entered my favorite time of the year: the silly season of Congress, College, and Professional Sports- and you thought I was going to be talking about Christmas!
Have you read the article recently published by the Penn Wharton Budget Model (PWBM) Staff? PWBM estimates that the Build Back Better Act (H.R. 5376) would increase spending by $2.1 trillion over the 10-year budget window while increasing revenue by $1.8 trillion, for a 10-year total deficit of $274 billion. By 2050, the proposal would decrease GDP by 0.2 percent, relative to current law. In an alternative, illustrative scenario in which all temporary provisions in the bill are made permanent, spending would total $4.6 trillion over the 10-year budget window. In this scenario, by 2050 the federal debt would increase by 24.4 percent and GDP would fall by 2.9 percent relative to current law. So, where did I hear this bill is free and won’t raise taxes? The rich will be getting a tax break when we bring back the State and Local Tax (SALT) write offs. This of course isn’t going to put any more pressure on inflation, is it? (sarcasm, if you can’t tell) Come on, man!
Continuing with inflation, did you see that Dollar Tree has officially announced that they have raised prices to $1.25? Well, that kind of seemed inevitable, but they say they can bring in better merchandise. We will see! I’m curious to see what the difference is between $1 merchandise and $1.25 merchandise- that seems kind of silly, huh?
Speaking of silly costs, did you see how much they pay college coaches just to go away, and the new contracts thrown around in the Coaching Carousel? USC is paying their new coach $100 million, while LSU is paying theirs $95 million. All this does is give the Alabama coach another automatic raise- who ever said playing a game doesn’t pay!
These colleges throw around millions of dollars as if we have an unlimited supply. I’m sure these are all wonderful people, getting paid a ridiculous amount for not even winning. Does it make sense that none of these people have cured cancer or heart disease? When are we as a country going to get our values and priorities straight? I will never understand how we can pay millions of dollars to coaches, athletes, Hollywood, and musicians and get so little in return other than higher inflated ticket prices. There are way more deserving workers in our country, such as first responders and teachers, that have done more for society than these people ever will. Stay safe, and see you soon.
Three Market Drivers
We focus on three market drivers that lead to notable movements in the stock market: economic fundamentals, technical environment, and investor sentiment.
Our fundamental indicator follows 19 economic datapoints that track the underlying health of the US economy. From unemployment to homebuilding, changes in these economic datapoints tend to confirm recession or recovery after the technical and sentiment indicators have already reversed.
Dynamic Asset Level Investing, or D.A.L.I., is a technical indicator that compares each of the major asset classes, sectors, and sizes and styles against each other to discover emerging trends in the market. D.A.L.I. compares daily price action of each of these elements on a point-and-figure chart to illustrate momentum. The chart at the bottom of this page shows the current leadership in D.A.L.I.
Our sentiment indicator tracks how everyday investors currently feel towards the U.S. economy and the stock market. Between our own polling and professional surveys like the American Association of Individual Investors (AAII) Investment Sentiment Survey and Citigroup’s Panic/Euphoria Model, we track the two most dangerous emotions for investors: fear and greed.
Source: Ycharts
Here is a breakdown of where each market driver currently sits:
It remains to be seen whether the Omicron variant will have a tangible effect on economic fundamentals, but the Federal Reserve meeting in mid-December should shed light on whether the variant will effect the Fed’s tapering timeline.
The RSI, or Relative Strength Index, measures recent price changes to determine undersold and oversold conditions. While the major market indices have seen their RSIs remain at healthy levels, many high-growth areas of the market have already reached oversold conditions.
Friday’s CBOE Equity Put/Call Ratio reached its highest level since October 4, the bottom of the previous 5% pullback in the major indices. This reading may indicate that investors are beginning to become less complacent in conjunction with the Omicron variant announcement.
Tapering: Right or Wrong
With inflation and a historically expensive market in the news, there has been constant debate in financial news around two familiar concepts: quantitative easing and tapering. Also, with the Federal Reserve’s December meeting coming up, these concepts are front and center once again. However, even though these phrases first rose to prominence back in 2008, many still do not understand what they actually mean.
Source: Ycharts
We would like to breakdown what these financial terms mean, and what kind of impact they have on the economy and stock market.
Before we can tackle the Fed’s current situation regarding tapering, we have to explain what quantitative easing actually entails. In layman’s terms, quantitative easing, or QE, is a program in which the Fed purchases financial assets, like bonds or stock, to inject money into the economy. This increase in money circulating in the economy typically helps to lower longer-term interest rates. These lower borrowing
costs are then expected encourage economic growth, which would then speed up an economic recovery. While QE was used both in 2008 and in 2020, there is not a consistent consensus amongst economists on the success of the program, or whether the program has negative or positive economic consequences.
One of the greatest fears associate with QE is hyperinflation, or out-of-control price increases throughout the economy. However, after 2008, the U.S. economy never experienced this anticipated hyperinflation, as most of the money injected into the economy was retained by banks to improve their balance sheets. However, with 2020’s crisis less contained to specific sectors of the economy, there is fear that there may not be the same outcome this time, with some inflation measures reaching 30-year highs as of late. Due to the unknown consequences of QE, discussions after the program have centered around another financial phrase in the news: tapering.
In short, tapering is the reversal of QE, including the slowdown and eventual reversal of the Fed’s financial asset purchases. Tapering is typically reserved for the point in which the Fed is confident that the economy is able to be self-sustained again; think of tapering like taking the training wheels (QE) off of the U.S. economy. While tapering is viewed as a necessary step to stabilize the economy after QE, there is not a significant track record of how the markets will react. A recent example in history is 2013, in which the U.S. announced plans to begin tapering following the Great Financial Crisis. As a result, the bond market droves yields higher, fearing that tapering would cause the economic collapse that QE was meant to prevent. However, after a few months, bond yields began to normalize as economic data began to be increasingly positive. Conversely, when the Fed began to actually reverse QE and raise rates, markets did not like the idea, as this was a contributing factor to the nearly 20% correction in the S&P 500 at the end of 2018. As a result, the Fed reversed course and ended its tapering prior to 2020.
Today, the Fed finds itself in a similar situation as 2013. While many economic indicators have yet to fully recover, many are improving, and the high consumer demand that has been highlighted by the supply chain bottlenecks indicates an economy primed to takeoff once it is in the clear. However, news of the Omicron variant may alter the Fed’s original tapering timeline, as they may anticipate further economic shocks from continued variant emergence. Either way, the stock market may find itself once again at odds with the Fed regarding the timeframe for tapering. Will the bond and stock market have strong volatility like it did following 2013’s announcement? Will QE once again have little to no impact on inflation, or will the money injected into the system circulate through the economy more freely this time? It’s hard to say, but it is worth paying attention to as more information comes out regarding inflation and future variants.
Market indices
Year-to-date returns
Large Cap indices
S&P 500: 23.94%
Dow Jones Industrial Average: 14.80%
Nasdaq-100: 27.24%
Mid and Small Cap indices
S&P 400 (Mid Cap): 20.60%
S&P 600: (Small Cap): 22.66%
Russell 2000: 13.53%
International indices
MSCI EAFE Developed Index: 4.64%
MSCI Emerging Markets: -5.60%
MSCI ACWI ex-US: 2.46%
Economic sector indices
Basic Materials: 19.42%
Communication Services: 21.20%
Consumer Discretionary: 25.84%
Consumer Staples: 8.04%
Energy: 47.21%
Financials: 31.71%
Healthcare: 16.32%
Industrials: 16.45%
Real Estate: 32.66%
Technology: 30.29%
Utilities: 7.37%
Santa Claus Rally: Does it Exist?
Every December, you may hear financial news outlets beginning to sound awfully similar to a Hallmark movie, consistently using the phrase “Santa Claus Rally.” Today we’d like to observe not only what the Santa Claus Rally is, but also whether there is any insight we can take away
Source: Ycharts
from their performance.
The Santa Claus Rally refers to a phenomena in the market in which the period consisting of the final five trading days of the year and the first two trading days of the new year historically exhibits robust returns. In fact, the Santa Claus Rally has averaged a return of 1.28% over the past 50 years. Which this seasonal phenomena has been a regular occurrence in market history, there is no specific reason that has been pinpointed for its existence. Some have theorized that the strong market is due to investors piling into the market at the end of the year in anticipation of a strong January and new year, while others have
suggested that the light trading volume during the holidays makes it easier for the market to ascend. Whatever the true cause of the Santa Claus Rally may be, its historic track record speaks for itself, as the Santa Claus Rally has had a positive return over 75% of the time since 1970.
Now, the question regarding the Santa Claus Rally is whether there is any insight to be gained from its performance. In the chart above, we looked at years in which the market had a positive Santa Claus Rally and years in which the market had a negative Santa Claus Rally. From this distinction, we then decided to look at two timeframes: how did the following January perform, and how did the following year in the stock market perform?
In the years with a positive Santa Claus Rally, the following Januarys were overwhelming positive, with nearly two-thirds of Januarys posting a positive gain. In the following year, the chance of a positive return was even greater, with years following a positive Santa Claus Rally having a positive return nearly 80% of the time. On the flip side, negative Santa Claus Rallies tended to have a negative effect on the following January, with only 42% of Januarys being positive following a negative rally. On the flip side, while negative Santa Claus Rallies didn’t lead to an 80% chance of a positive return the following year, they still had a significant chance of positive returns, with roughly two-thirds of years following a negative Santa Claus Rally still posting a positive gain.
In short, while a negative Santa Claus Rally may not lead to a strong January, the following year still has a solid chance of being positive. On the flip side, a positive Santa Claus Rally has overwhelmingly led to strong Januarys and strong years following the rally. While the Santa Claus Rally is just another one of the many inexplicable phenomena in the stock market, it’s worth tracking if history is to be our guide.
Chairvolotti Financial, Inc. dba 401karat is a Registered Investment Advisor.
