In this week’s narrative, we discuss the recent selling within the equity markets. We also review the comments from Fed Chairman Powell at last week’s Senate Banking Committee hearing and preview the November jobs report. We then discuss the recent underperformance of small-cap stocks and the fact that many of these issues have traded to 20-day lows. Finally, we highlight the widening spreads on high-yield bonds, which we will be closely monitoring as an indicator of the underlying health of the U.S. economy.
Black Friday Sell-Off – While investors may have been in a buying mood in the malls or online the day after Thanksgiving, they were selling on Wall Street. Stocks ended the shortened trading session sharply lower, with the S&P 500 giving up 2.3%. Trading volume, which is often limited as many take an extended holiday weekend, was actually relatively high, nearly double the figure from 2020. The sell-off was triggered by news of a new COVID-19 variant, first detected in southern Africa. While there is limited information regarding this new strain, Omicron, the belief is that it may be more easily transmitted but that those infected may exhibit less severe symptoms relative to certain other strains of COVID-19. While the S&P bounced back last Monday to reclaim more than half of its losses, the selling resumed last Tuesday. By the close of trading last Wednesday, the return on the Index since Thanksgiving stood at -4.0%. Given what is known about Omicron at this juncture, we believe it is premature to take any investment action regarding the potential outcome of this new variant. That said, we are actively following the new strain and its potential impact on the economy and will revisit our investment posture if and when facts dictate such a move.
Powell Speaks to Congress – Last week, Fed Chairman Powell spoke to the Senate Banking Committee. In his prepared statement, he indicated that the Omicron variant of COVID-19 risked intensifying supply-chain disruptions, which have been one of the causes of recent inflationary pressures. He went on to say, “It is difficult to predict the persistence and effects of supply constraints, but it now appears that factors pushing inflation upward will linger well into next year.” He also mentioned the rapid improvement in the labor market, with slack diminishing, and wages rising at a brisk pace. While the pace of tapering was not mentioned in his statement, shortly after his actual testimony began, Chairman Powell indicated that the Fed would discuss speeding up the pace of tapering at its December meeting. That comment, seemingly an acknowledgment that transitory inflation could be more persistent than expected, was not well received by the financial markets. The Dow shed nearly 500 points in short order. While Fed policy has been very supportive of the economy and financial markets post COVID, we believe it will continue to be accommodative over the near term, if only somewhat less so than in the recent past.
November Employment Report – Last Friday morning, after the publication deadline of this narrative, the Labor Department announced the employment statistics for November. With the Fed beginning to step back from its unprecedented support of the U.S. economy, it is vital that the employment picture continue to be supportive of a handoff to the consumer. Consensus estimates called for nonfarm payrolls to increase by 535,000 and for the unemployment rate to decline to 4.5%, from its current reading of 4.6%. It should be noted that estimates have varied widely from actual results over the past couple of months, with October’s announced figure exceeding estimates by over 100,000, while September’s reported new hires fell a staggering 294,000 jobs short of estimates. This report is always important to the markets, and all the more so given recent announcements and comments from the Fed.
Returns Table
| Equities | Week(%) | YTD(%) | 1-Year(%) | 3-Year(%) | 5-Year(%) | Div Yield |
|---|---|---|---|---|---|---|
| S&P 500 | 0.6 | (0.8) | 26.1 | 24.25 | 17.94 | 1.22 |
| Russell 1000 Value | 1.2 | 1.5 | 22.7 | 16.79 | 11.35 | 1.77 |
| Russell 1000 Growth | 0.0 | (3.5) | 23.4 | 30.79 | 23.83 | 0.64 |
| Russell 2000 | (0.8) | (3.1) | 3.3 | 16.00 | 11.25 | 0.94 |
| MSCI EAFE | (0.5) | 0.7 | 10.3 | 12.91 | 9.74 | 2.51* |
| MSCI EM (Emerging Markets) | 3.7 | 2.9 | (4.0) | 11.03 | 10.03 | 2.38* |
| Fixed Income | Week | YTD | 1-Year | 3-Year | 5-Year | Div Yield |
| Bloomberg Barclays US Aggregate | (0.3) | (1.5) | (1.9) | 4.21 | 3.16 | 1.98 |
| Bloomberg Barclays US High Yield – Corporate | (0.2) | (0.6) | 4.6 | 7.50 | 5.93 | 4.45 |
| Bloomberg Barclays Municipal Bond | (0.7) | (0.9) | 0.7 | 4.30 | 3.74 | 1.31 |
| Bloomberg Barclays Global Aggregate x US (Country) | 0.3 | (0.3) | (5.8) | 2.44 | 2.94 | 1.15 |
| Commodities | Week | YTD | 1-Year | 3-Year | 5-Year | Current Level |
| Crude Oil WTI (NYM $/bbl) Continuous | 6.2 | 9.9 | 55.3 | 17.0 | 9.3 | 82.6 |
| Natural Gas (NYM $/mmbtu) Continuous | 16.6 | 21.6 | 59.8 | 13.7 | 5.1 | 4.3 |
| Gold NYMEX Near Term ($/ozt) | 0.1 | (0.0) | (0.9) | 12.4 | 8.8 | 1,827.2 |
| Copper Cash Official LME ($/mt) | (1.2) | (0.2) | 21.1 | 17.7 | 10.9 | 9,665.0 |
| Currencies | 1 Week Ago | YTD | 1-Year Ago | 3-Years Ago | 5-Years Ago | Current Level |
| U.S. Dollar per Euro | 1.13 | 1.24 | 1.22 | 1.15 | 1.07 | 1.14 |
| Japanese Yen per U.S. Dollar | 115.79 | 115.16 | 104.20 | 108.41 | 114.03 | 114.85 |
| U.S. Dollar per British Pounds | 1.36 | 1.35 | 1.36 | 1.28 | 1.22 | 1.37 |
Small-Caps Underperform
As noted earlier, the S&P 500 declined by 2.3% on Black Friday, but the damage down the cap spectrum was more severe, with the Russell 2000 Index of small-cap stocks suffering a loss of 3.7%.
While the S&P 500 bounced back with a gain of 1.3% last Monday, selling pressure continued within the small-cap universe, as the Russell 2000 Index again registered a decline, albeit just -0.2%.
As of last Wednesday’s close, the post-Thanksgiving return for the S&P 500 stood at -4.0%, vs. a decline of -7.9% for the Russell 2000 Index.
The chart above was compiled after Black Friday and indicates that nearly 50% of the Russell 2000 Index recently traded to a 20-day low.
In the past, when this has occurred, it has often proved to be a buyable event. We remain overweight on small-cap stocks and believe that the recent underperformance of this group is likely to reverse over the coming weeks.
Watching Credit Spreads for Signs of Stress
On Black Friday, the spread on high-yield bonds widened out 30 basis points, to 341 basis points, which represented the widest spread since February.
High-quality U.S. Treasuries were bid higher (yields lower), with high-yield bonds going the other direction, which resulted in the significant widening.
Spreads tightened last Monday but then widened out again the following day. So far, this action has coincided with moves within the equity markets; that is, high-yield bonds have traded in sympathy with other risk assets.
Still, this is something we will be closely watching going forward, as widening yield spreads are often a good indicator of increasing concerns with respect to the underlying health of the economy.
We will be far more concerned if high-yield spreads diverge from moves in the stock market. Specifically, if stocks move higher and low-quality bond spreads continue to widen, which to date has yet to be the case.
