3th - 7th Jan 2022 Weekly Round-Up: FOMC December 2021 Meeting Minutes

Saturday, 8 Jan 2022 2:40 PM EST

After the favorable Santa Claus rally, stocks were doused with cold water this week. The tone of the week was set on Wednesday, after the December Federal Reserve meeting minutes were released, dragged down the high-valuation growth stocks. The greatest change to the prevailing narrative this week was on the likely course of monetary policy from the Fed given what was unearthed:

"Regarding the outlook for U.S. monetary policy, expectations for a reduction in policy accommodation shifted forward notably. Respondents to the Open Market Desk's surveys of primary dealers and market participants broadly projected that the Committee would quicken the pace of reduction in the Federal Reserve's net purchases of Treasury securities and agency mortgage-backed securities (MBS), and the median respondent projected net asset purchases to end in March 2022. The median respondent's projected timing for the first increase in the target range for the federal funds rate also moved earlier from the first quarter of 2023 to June 2022."

What this means in English is that the market has now understands and expects bond purchase to end in March 2022 and the first interest-rate hike to take place between March and June 2022. 

Because the Fed's monetary policy has been so accommodative to the market, its balance sheet is the highest that it has ever been. This is seen as a deficit on their end and at some point they have to reduce the size of their balance sheet. This is known as "quantitative tightening" that we will likely hear to be the main topic of discussion this year (in contrast to a period of "quantitative easing" since the pandemic started). On the normalization of monetary policy (i.e quantitative tightening):

"Participants  had an initial discussion about the appropriate conditions  and timing for starting  balance sheet runoff relative  to  raising  the  federal funds  rate  from  the ELB. [...] Almost  all participants agreed that  it would  likely be appropriate to initiate balance sheet runoff at  some point after the first increase  in  the  target range  for the federal funds rate. However, participants judged that the appropriate timing of balance  sheet runoff would likely be closer to that of policy rate  liftoff than  in the Committee’s previous experience.  They  noted that current conditions included a stronger economic  outlook, higher inflation,  and  a larger  balance  sheet  and thus could warrant a  potentially faster  pace of  policy rate normalization.   They emphasized that  the  decision  to initiate runoff  would be data dependent." 

In English, this means the Fed may be warranted to increase its pace of tightening monetary policy "sooner or at a faster pace than participants had earlier anticipated."

Compared to three months ago, the CME FedWatch Tool now shows a 66.6% probability the Fed will boost interest rates by 0.25% at its March 2022 monetary policy meeting. That same tool shows a greater than 50% probability of a similar rate hike after the Fed's May 2022 monetary policy meeting, with greater probabilities for one to two other rate hikes than just three months ago.

Exacerbating the situation was St. Louis Federal Reserve President James Bullard who Thursday said he sees an initial interest rate increase happening as soon as March "as the U.S. central bank seeks to quell the hottest inflation in nearly four decades." Bullard, a voting member of the Federal Open Market Committee this year, also suggested Fed policymakers may immediately pivot to raising rates once the Fed concludes its massive bond-buying program in March. Bullard went on to say, "Subsequent rate increases during 2022 could be pulled forward or pushed back depending on inflation developments."

Given the recently shifted tune from the Fed, from focusing on unemployment to now focusing on inflation, it likely means they are looking past the disappointing job creation figures in the December employment report and focusing on the stronger-than-expected wage gains data. Per that report, hourly wages rose a stronger-than-expected 4.7% year-over-year vs. the expected 4.1% figure and November's 4.8% gain. Tucked inside the report, a record 48% of U.S. small business owners said they raised compensation in December and nearly a third said they plan to do so on the months.

Should the combination of December 2021 consumer price index (CPI) and producer price index (PPI) readings due next week come in at either elevated levels or hotter-than-expected ones, we continue to think we will experience another round of market volatility that weighs on growth stocks as the market prices in an even greater likelihood of potential Fed rate hikes in the coming months. 

As we faded into the weekend, we monitored the latest on the Omicron front. On Friday, Germany decided to toughen requirements for entry to restaurants and bars. Late in the week, organizers of the annual E3 video game developers conference announced 2022 June conference will be held virtually. On the testing front, the federal government is reported to be finalizing plans with the U.S. Postal Service to begin to deliver hundreds of millions of Abbott at-home Covid tests on demand starting in mid-January.

Oil prices moved higher this week, despite OPEC+ sticking to an agreed output target increase. Taking some of the steam over that news was the shortfall in expected production from OPEC in December. A survey of OPEC-only production figures showed oil production grew 70 thousand barrels per day (kb/d) in December, well short of the 253kb/d increase permitted for the OPEC-only Nations.

State Of The Portfolio and Outlook 

Coming into the new year, we had been sitting on a heavy cash position (~20%). Through out the week, despite making many buying and selling actions, we still kept the same modestly high cash position because we believe that will be our greatest advantage in the coming volatile market conditions. As we've said towards the end of last year, and would like to re-iterate now, even though we're still on a path towards modest economic growth in 2022, monetary policy from the Federal Reserve remains the biggest uncertainty, as any misstep can significantly hamper economic growth and kill the current bull market. We believe the market in 2022 will be full of rotations just like much of 2021, and our strategy right now is to sell to the market what they love and buy from the market what they hate.   

This week, high-valuation growth stocks took the brunt of the market selloff and that reverberated through our shares of Microsoft (MSFT) , Apple (AAPL), Salesforce (CRM), Advanced Micro Devices (AMD). Despite those moves lower, the bright spots in the portfolio were industrial/ cyclical/ value stocks such as Ford Motor (F), Boeing (BA), Wells Fargo (WFC), Morgan Stanley (MS) shares. 

Summary of Actions (all have been reflected on our holding sheet):