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Too Early to Call the End of Bull Market!!

After two years of stellar returns, Investors have started asking how long this bull market can last. To add to their nervousness, the media continues to bombard the investment community with reasons to worry. Market jitters were evident on November 26th when the North American markets dropped -2% to -2.5% when news of the Covid-19 virus variant “Omnicron” broke.

While news of the latest variant acted as the catalyst, we believe that uneasiness was already palpable in markets for some time. They have been moving sideways for most of the month as investors waited on Biden’s decision regarding the Federal Chair and as expectations increase that persistent inflation will force the Fed’s hand to increase the pace of tapering of its bond buying program. The historically high valuations, high inflation rates, announcements regarding winding down of monetary stimulus, and talks of central banks increasing interest rates in 2022 are all contributing factors to set up for a pullback.

As markets do not move in a linear fashion, pullbacks can be common even during bull markets. Such pull backs are typically short-lived and are difficult to time correctly. Thus, the wisdom of “Buy and Hold” and “do not try to time the market” rings true. Often, in trying to time the markets during the short-term pullbacks, investors find themselves selling at the low or waiting too long to get back in for the upside. How does one avoid wealth destruction during prolonged periods of stress? In our view, the key is to know the stage of a business cycle and watch out for signs of the start of a bear market. A pivot to a defensive stance is prudent during bear market as risk assets typically move downwards for a longer period.

Below we investigate many of the concerns playing on investors mind today and determine that it is premature to expect a bear market anytime soon.

  1. A new variant: The drawdown on November 26th on the news of a new variant “Omicron” that could potentially evade immunity form vaccines was a stark reminder that pandemic is very much ongoing. Current vaccination progress, and the knowledge gained in managing Covid-related risks indicate the economic risks from a new variant, if it spreads, could be mitigated.

  2. High inflation and interest rates: The transitory inflation narrative is increasingly being dropped as inflation numbers have consistently surprised to the upside. The current stance of Federal Reserve is that if inflation continues to be more persistent, they have the tools to contain the inflationary pressures, i.e., by increasing interest rates. While a factor, an increase of interest rates and high inflation does not in itself imply the end of a bull market. We highlight periods in history when the Feds increased interest rates, inflation was rising, and S&P 500 index continued to advance (see Chart).

Interest rates and inflation S&P 500

Source: Bloomberg

  1. Could Fed fast track the timeline to tighten monetary conditions?: As the financial wisdom goes - “Bull markets do not die of old age, they are rather killed by Federal Reserve”. The risk of bear market will arise if the Fed is forced to tighten monetary conditions too quickly, too much, or more than necessary. This in turn will choke the economic activity by making it tough to borrow or service debt and induce an economic recession. Since the US President has nominated ‘Jerome Powell’ for the second term as a chair of US Fed, we think the choice is made for stability and policy continuity. Given Mr. Powell’s track record in the position and his reputation as a dove (preference to keep monetary conditions loose), we think it is reasonable to expect that the Fed Chair is likely to err on the side of caution and will tolerate a lot of inflation before deciding to increase interest rates. That said, persistently high inflation could force the Fed’s hand and thus it is a risk worth monitoring.

  2. High Valuations: As a result of record low interest rates, money printing, and fiscal stimulus the asset values are at their historic highs. One implication of high valuation is that the expectations of future returns are low. As high growth is now priced in the valuation, another implication is that one can expect relatively higher volatility as investors’ expectations of a growth outlook can change with the ebb and flow of developments such as a new variant, inflation, or a potential increase in interest rates.

Given that the GDP is forecasted to continue to grow in 2022, that unemployment is on a consistent decline, and that consumer demand is strong, we infer that the economy is in healthy spot overall. Eventually, the economy will go through its cycle of expansion and contraction and stocks markets will go through their cycle of bull and bear market; however, from where we stand today, the economic data does not indicate a contraction and/or a bear market soon.

November in Review

  1. The S&P 500 and S&P TSX advanced for most of the month but gave up their gains towards the end of the month on concerns of a new variant of Covid-19 virus and policy uncertainty on commencement of interest rates hike cycle.

  2. As a part of his economic agenda, US President Joe Biden signed a US$1.2 trillion infrastructure bill into law in early November. The bill outlines ~US$550 billion of investments in infrastructure over five years.

  3. US Fed Chair, Jerome Powell was selected for a second four year-term and governor Lael Brainard was appointed as a vice chair of the US Federal Reserve

  4. The headline inflation number for October came in at 6.2% for the US. The corresponding number for Canada was 4.7%

  5. Early in the month, the US federal Reserve released its policy statement and announced commencement of its tapering of bond buying program late in November 2021

  6. Late in the month, while speaking in front the Senate Banking Committee, Jerome Powell said that its is now time to drop the word transitory for inflation and consider accelerating the pace of tapering the Bond buying program.

  7. Canada’s GDP for the third quarter was stronger than expected at +5.4% (expectations of +3.0%) underpinned by household spending.

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