For the second month in a row there were notable changes to the Market Multiple Table, as we saw two market influences removed (Washington/Tax Hikes and Rising Bond Yields) and they were replaced by the Omicron variant, but for all the changes the general message of the Market Multiple Table remains the same: While a steep drop in stocks is unlikely (at least due to fundamental reasons) the market is still priced to near perfection, and as a result we should expect increased volatility and periodic “air pockets,” while the market remains in search of a catalyst that can take it materially higher.
In a testament to the market’s resilience, two of the market influences from November, Fed Tapering Pace and Date of First Rate Hike, has the “Gets Worse If” scenario occur over the past month as the Fed confirmed it’s going to meaningfully accelerate tapering of QE while the date of the first rate hike has been pulled forward to June. That caused a drop in stocks, but markets have bounced back over the past two days (although there isn’t a solid fundamental reason for that, although with less than 20 trading days left in the year, markets don’t need a fundamental reason to hold onto big YTD gains).
Meanwhile, Washington has moved to the macroeconomic “back burner” as there won’t be a spending bill passed in 2021 (so no tax increases for the foreseeable future) while Congress avoided a debt ceiling breach and government shutdown. So, for now, Washington is not a major influence on markets. Similarly, the Omicron fears crushed Treasury yields and while we think they eventually recoup those losses, the 10-year yield remains far below levels that would make stocks nervous and it’s unlikely to get to those levels in the next several weeks.
Bottom line, market influences are shifting, but by far the major influence on markets going forward is the Fed (barring a surprise from Omicron) so what the Fed decides next week will likely determine if we get a Santa rally into year-end.
Current Situation. The current situation reflects the numerous changes to the macro influences on the market over the past month (which resulted in the recent volatility). As said, by far the biggest influence on the market is Fed policy, and specifically whether the Fed meets market expectations next Wednesday or provides a hawkish or dovish surprise. Omicron is still an influence on stocks, but only because we don’t know officially whether the existing vaccines provide a high degree of protection from severe illness. As we covered last week, Omicron will only substantially influence the markets if it causes a shutdown, and for that to happen the vaccines will have to be declared ineffective against Omicron, which at this point seems unlikely.
Stepping back, the current situation accurately reflects the market reality: The Fed is the major influence on markets right now, Omicron is a potential influence but does not appear to be a sustainable threat to stocks, and despite Fed uncertainty, stocks are still priced for relative perfection, which leaves this market vulnerable to “air pockets” and continued volatility (although a sustainable correction remains unlikely barring an Omicron or Fed surprise).
Things Get Better If: The Fed Accelerates Tapering By Less than $30/billion Month, The First Rate Hike Won’t Come until June 2022 and We Only Get Two Hikes in 2022, and PFE and MRNA Officially Release Results Stating Vaccines are Effective Against Omicron. This would essentially be the “best case” scenario for stocks as it’d remove COVID as a risk while at the same time show the Fed isn’t going to drastically remove accommodation. In this scenario, we could see markets push to a 21X multiple given still low rates, while earnings expectations would rise incrementally. But that only represents less than 2% upside from current levels, although we’d not be surprised if stocks extended beyond that based on a Santa rally.
Things Get Worse If: The Fed Accelerates Tapering To More than $30 billion/month, Hints at Three Rate Hikes in 2022 or COVID Vaccines are Labeled Ineffective Against Omicron. Positively, these appear to be unlikely events (all three) as the Fed is unlikely to truly shock markets while all the anecdotal evidence with Omicron implies vaccines will hold up decently well. But while this outcome is unlikely, it’s worth noting that the downside is significant, as there’s really no support for an environment like this for at least 10%-15% in the S&P 500.
Bottom line, the MMT clearly shows us this is a market that’s all about the Fed. And while we are at the top of valuation ranges and stretching the bounds of fundamentals, given the calendar, if the Fed isn’t as hawkish as feared and Omicron ends up being a relative nonevent, then the Santa rally can extend into year-end, even if it does stretch beyond the bounds of fundamental justification.
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Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President