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Here we go again. Or maybe, more accurately here we go still. COVID has reared its ugly head again, this time in the form of a new variant called Omicron. The name surprised some folks because the next letter in the Greek alphabet was Nu but the WHO thought that sounded too much like “new” so they skipped that one as Greek speakers are generally confined to Greece these days. And the next letter was “Xi” which the WHO said was a common last name and that their policy required “avoiding causing offense to any cultural, social, national, regional, professional, or ethnic groups.” Well, goodness no, wouldn’t want to offend anyone, certainly not the most famous man with the last name of Xi. What I’m trying to figure out is if I actually slept through epsilon, zeta, eta, iota, kappa, lambda and mu or if WHO thought those might offend someone too, like maybe some fraternity or sorority. They sure didn’t seem to mind offending Animal House fans by naming the last one Delta. Maybe they were worried about offending nerds (Lamda, Lamda, Lamda). Ah, WHO cares?
About the only thing we know for sure is that last Friday’s selloff didn’t have anything to do with the name because that happened while the WHO was deep into research on the Greek alphabet and who it might offend. We were having a nice pleasant Thanksgiving week, eating turkey and ham and yams, watching football – if that’s what you call what the Lions play – and just generally enjoying a couple of days away from the market when WHAM! Here comes Mu or Nu or Xi or Omega or whatever and the market tanks like it hasn’t done since all the way back in February. Worst week since, um, well, last month. The S&P 500 was down 2.2% last week which, in normal times, would be barely worth a mention. But in today’s speculative market, that qualifies as a correction and Twitter is all atwitter this evening about the rebound everyone expects tomorrow.
We don’t know anything about this new variant yet and so there is no way to judge the impact. Yes, some countries are closing borders but they can be opened just as quickly. I have said since the onset of this pandemic that we better learn how to live with this thing because it isn’t going away. And unless Omicron turns out to be an extremely deadly version of COVID, my guess is that people are just going to go on with their lives; COVID exhaustion has set in. So, whatever the state of the economy was prior to the arrival of the big O, that’s what it is now too no matter the WHO’s permanent state of panic.
The global economy is still recovering from the COVID shock – the shutdowns and the response. The first two quarters of this year were a big rebound as the vaccines were rolled out. Last quarter was a bummer with the emergence of the delta variant (or at least that was the accepted wisdom). And this quarter so far is looking like a pretty good rebound from that slowdown. The Chicago Fed National Activity index rebounded in October to 0.76, a big improvement from -0.18 in September. The 3 month average is now 0.21, showing growth as just a bit above trend. Until the new variant news hit Friday, markets were starting to confirm the improvement in the economy. Both nominal and real rates were up on the week – for a change – and the economic data was almost uniformly positive. But rates were down hard on Friday and finished the week in the red. We’ll see if that lasts this week.
When it comes to economic and market data I try not to react too much to any one report. I learned a long time ago that the first pass on economic data is really just a guess and revisions can change your entire view of the economy. And this week we got reason number bajillion why that is true. Last month we got a report on goods trade that showed a large drop in exports. A lot of pixels were expended in explaining why that was a big warning sign about the global economy. But the drop was confined to one category of goods called “industrial supplies” and I warned that we didn’t know what caused it. Well, since then we discovered that the biggest drop was in “non-monetary gold” which means essentially nothing to the global economy. I don’t know why it dropped that month but it rebounded this month and the entire drop has now been wiped away. There were some other weak items in that category as well – crude oil and petroleum products – but none of it was that surprising or important to the global economy. The point is that one shouldn’t make any rash judgments about the markets or the economy based on one report.
And the same applies to the latest virus news, whatever it might be. The emergence of the Omicron variant could be negative – or not. It may evade the vaccines – or not. It may be deadly – or have mild symptoms with low hospitalization and death rates. We just don’t know. I do believe, based on my own reading about coronaviruses, that COVID-19 will eventually mutate into something our immune systems can handle. It could become like the flu or even better like the common cold (which is actually a bunch of viruses). That is, after all, what coronaviruses do (not all viruses obviously). They evolve and mutate to a form that allows it and its host to survive. How long that takes is anyone’s guess but if history is a guide it doesn’t happen quickly. You could be talking years before we reach that point. In the meantime, we need to do the best we can and live with it. Because it isn’t going away. Still.
As I said above, the economic data released last week was almost uniformly positive. New and existing home sales rebounded although both are still down year over year. Durable goods were lower for the second straight month but ex-transportation orders were up a solid 0.5%, the eight consecutive monthly gain. Core capital goods were also higher again, up 0.6% for the sixth consecutive gain.
Personal income and consumption were both up in October as wages and salaries continue to move up. Incomes fell off some after the end of the extended unemployment benefits but that is rapidly fading in the rear view mirror. Consumption remains well above the pre-COVID trend and shows little sign of abating. And by the way, that is true of real, inflation adjusted consumption too. Incomes are still struggling a bit after inflation and taxes are taken into account; real disposable income was down 0.3% last month and 0.9% year over year.
Despite that we continue to classify the current environment as one of falling growth. That is primarily due to real rates which are still near their lows of this cycle at -1.07% for the 10 year TIPS. The nominal 10 year at 1.48% is still quite a bit below the peak last spring of about 1.75%. Lastly, the yield curve continues to flatten although it is still a long way from flat or inverted. The dollar is also still in an uptrend, hitting its highest level since June 2020 last week before pulling back on Friday. While we might see some near term weakness the short term trend is obviously up.
We get more housing data this week in the form of pending home sales which will give us a better idea of how the market is right now.
Jobless claims should be interesting this week. Last week’s report dropped under 200k. The last time initial weekly claims were that low the summer of love was just ending (September 1969 for all you youngsters out there). It seems like a possible seasonal adjustment mistake but maybe not. The trend should put this week’s number up around 250k.
We get payrolls this week and that is often a market moving event. It is backward looking and subject to huge revisions but for some reason people still pay attention so we will too, at least for this week.
Finally, we get the ISM reports this week.
Stocks were down across the board last week while bonds were mostly higher (in the chart below is shows the 3-7 Year Treasury index as down for the week but that is wrong for some reason; the ETF for the index was up on the week.) Corporate bonds, high grade and junk, were down last week as spreads have widened every so slightly. Junk spreads are still very tight historically so just something to keep an eye on at this point.
Commodities also took a beating last week as crude oil dropped below $70. Blame it on omicron I guess but it was due for a pullback in any case. The commodity line below is the GSCI index which we sold months ago. Our preferred index right now is the BCOM which was down about half as much as the GSCI last week. In any case, commodities are still the best performing asset of the ones we track and own in our portfolios.
In a strong dollar year it isn’t surprising to see foreign markets lagging. Global ex-US stocks are up just about 5% this year while EM, Asia ex-Japan and China are all down YTD. Japan is clinging to a small gain. It is hard to fathom the gap in performance between US and international markets over the last decade. Just truly stunning and the reversal, when it comes, will likely be just as spectacular. But we aren’t there yet.
Value outperformed last week but it wasn’t anything to write home about.
With everyone expecting the market to rebound tomorrow I wouldn’t be surprised at all to see us take another leg down. A lot of Friday may have been nothing more than a convenient excuse to take profits in a wildly overvalued market. A 2% down day hasn’t changed that. About the only thing that would is a certified bear market but with the economy at least okay for now, that doesn’t seem likely. So, what do we do to our portfolios? Nothing is the usually the best answer to that and this is no exception. Our portfolios continue to be defensive with a larger than normal allocation to cash. That’s what the current environment of falling growth and rising dollar calls for. Maybe omicron will be the catalyst for the long overdue correction of at least 10%. With margin debt as high as it is, it probably wouldn’t take much more to really accelerate the selling, forced or otherwise. And 10% is nothing, a normal market fluctuation that comes, on average, about every 19 months. This is the 20th month since the bottom of the COVID bear. Just sayin’.
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