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Key Points for the Week

  • The personal consumption expenditures (PCE) price deflator rose 0.6% and is up 5.7% in the last 12 months. The annual increase in the PCE inflation rate is the highest since 1982.
  • The housing market remains tight. Existing homes sales increased 1.9% and the supply of existing homes for sale decreased 13%.
  • Stock market volatility has increased in recent weeks as the market has reacted to adjustments in Fed policy and the Omicron variant.

Investors were feeling bullish.

Last week, the Standard & Poor’s 500 (S&P 500) Index closed at a record high for the 68th time this year. That’s the second-highest number of record closes in a single year. The highest number occurred during 1995, when the S&P 500 had 77 record highs, reported Reuters. That was the year the Dow Jones Industrial Average passed 4,000 for the first time and then rose above 5,000, reported Wayne Duggan of Benzinga.

The market deserves to celebrate. [COVID] brought death and dislocation, but we tend to pay too little heed to what didn’t happen. If vaccines hadn’t changed the pandemic’s trajectory, the U.S. would have suffered nearly 1.1 million additional deaths and 10 million more hospitalizations – according to an epidemiological model by the Commonwealth Fund cited this past week in the Journal of the American Medical Association.

Bill Alpert, Barron’s.

That may be the case, but investors were likely focused on expectations for consumer sentiment, economic growth and corporate earnings.

The Conference Board reported that the consumer outlook for income, business and labor market conditions improved significantly in December, rising from 90.2 to 96.9. A growing share of survey respondents plan to buy houses, cars and major appliances during the next six months. The number of people planning vacations increased, too, reported Lucia Mutikani of Reuters.

Consumer optimism could bode well for economic growth, which was robust in 2021, up 6.3 percent in the first quarter of the year, 6.7 percent in the second quarter, and 2.3 percent in the third quarter. The U.S. Bureau of Economic Analysis reported, “From the second quarter to the third quarter, spending for goods turned down (led by motor vehicles and parts) and services decelerated (led by food services and accommodations).”

Despite the July to September slowdown in GDP, corporate earnings remained unusually strong. Earnings are a measure of companies’ profitability, Analysts estimated that the corporate earnings growth rate for 2021 is 45.1 percent, year-over-year. That’s well above the trailing 10-year average annual earnings growth rate of 5 percent, reported John Butters of FactSet.

All sectors of the S&P 500 Index are expected to have had positive year-over-year earnings growth in 2021. Energy, Industrials, Materials, Consumer Discretionary and Financials sectors have experienced the strongest growth.

We hope the new year is filled with good health and prosperity.

This Week in the Markets

The PCE price deflator confirmed inflation remains a strong challenge for the U.S. economy, rising 0.6% last month and 5.7% in the last 12 months. The annual increase was the highest since 1982. Core PCE inflation rose 0.5%, suggesting food and energy prices rose only slightly more than broad consumer prices.

Prices have risen rapidly in the housing market. Existing home sales increased 1.9% last month and supply dropped 13%. The median price for an existing home rose to $354,000 and the median price for a new home is now $417,000.

Stock market volatility has increased. The S&P 500 moved by 1% more often in the past four weeks than in any other four-week period this year. Fortunately, the moves were primarily to the upside. The S&P 500 index added last week and eclipsed the previous all-time high. The MSCI ACWI gained as well, while bond yields rose and bond prices fell. Data releases are light this week as the PCE data came out one week early.

Did You Get My Letter?

During this holiday week, we’ll answer a couple of the questions we’ve received about how the market is responding to the current environment.

Will the market go down or get more volatile because interest rates are rising?

The Federal Reserve normalizing rates can increase risk and volatility. Recent history suggests rate hikes don’t have as much immediate impact as we might think. The last time the Fed reversed direction and increased rates was 2015, with a single hike in December. It waited another 12 months for the next hike in December 2016 and then hiked rates three times in 2017 and four times in 2018. S&P 500 returns were a little below average during those four years, with stocks rising about 7% per year. In 2017 the market earned more than 20%, and the S&P 500 had a mere eight moves of more than 1%. The 2004-2006 period included 18 interest rate hikes; yet, stocks fared decently. Returns were similar to the most recent rate-hike cycle, rising 6.6% each year.

In both cases the rate hikes had to be at least partially reversed as economic conditions changed. Signs the economy was slowing precipitated three rate cuts in 2019. The Fed cut rates again to support the economy during the COVID-19 pandemic. Rates were very low in 2004 because they had been cut to support the economy as the technology bubble unwound. Rates were too low and led to speculation in the housing market which then contributed to the global financial crisis.

We counsel patience during periods like this one:

  • Stock market returns are likely to slow after three straight years of strong growth. In the last two cycles, investors who pulled out of the market when rates were first hiked and reinvested at the last hike missed out on about 70% of returns.
  • This rate-hike cycle will likely have fewer hikes than the last two. In 2006 rates peaked at 5.25%. Rates only reached 2.5% in 2018, and the Fed expects that to be in line with long-term rates. We are less optimistic about the economy and think the Fed will raise rates slowly and not above 2%.

Why do the CPI and PCE price deflator show a gap of more than 1%?

The Consumer Price Index or, more technically, the CPI for All Urban Consumers (CPI-U) and Personal Consumer Expenditures Price Index both measure inflation but use different methodologies. Each measure also has a “core” version that excludes food and energy price changes. The Federal Reserve prefers to use the core PCE inflation index for the following reasons:

  • Food and energy prices are more volatile and often don’t reflect price trends in the broader economy.
  • The PCE index adjusts the weight of various items more quickly based on changing consumer behavior than the CPI index. The PCE inflation index also allows for substitutions consumers make when the price of a good increases, better reflecting consumer behavior.
  • The PCE index includes expenditures made on the behalf of consumers by insurance companies or the government. This also reduces the impact of housing prices on the PCE compared to the CPI.

The high inflation rate has been reducing benefits that would normally accrue to workers, an important point to note in this season of giving. The Fed’s tighter money supply combined with less federal spending and the normal workings of capitalism should start to push the inflation rate lower soon.

Beeple, the Ever Given and Billionaire in Space

If you had to describe 2021 with a single word, what would you choose? Innovative? Frustrating? Too much? Something saltier? It certainly wasn’t an easy year. As we say goodbye to 2021, let’s not forget:

  • Beauty is in the eye of the beholder. Non-fungible tokens were among the manias that gripped the global community during 2021. Consider the case of Beeple, a digital artist from Wisconsin who is also known as Mike Winkelmann. Before 2021, the highest price commanded by a Beeple print was $100, reported Jacob Kastrenakes of The Verge. Then his collage, The First 5000 Days, became the first digital artwork offered for sale by a prestigious auction house. It sold for more than $69 million.

    Commenting on a picture in the collage, the visionary digital artist said, “It’s a picture of my Uncle Jim, who I nicknamed Uber Jay. I probably would have spent more time on this, had I known it would eventually be part of a piece auctioned by Christie’s!”

  • Misadventures of the Ever Given. Global trade was disrupted last March when one of the world’s largest cargo ships became wedged in the Suez Canal, blocking all of the ships trying to access the canal for six days. After it was freed, the ship was impounded for three months while reparations were negotiated, reported the BBC.

    Its predicament briefly transformed international shipping into a spectator sport. Azmi Haroun of The Insider reported, “Social media users were quick to find deeper meaning in the ‘Big Engine That Couldn’t.’”

  • Billionaires in Space. Jeff Bezos and Richard Branson journeyed into space along with various guests, courtesy of their respective space programs. Elon Musk’s private spaceflight company shuttled NASA astronauts to the International Space Station (ISS). Japanese entrepreneur (and former drummer in a punk rock band) Yusaku Maezawa become the first billionaire on the ISS. He journeyed by Russian rocket, reported the BBC.

    In 2016, Musk explained his focus on space travel. “History is going to bifurcate along two directions. One path is we stay on Earth forever, and then there will be some eventual extinction event…The alternative is to become a spacefaring civilization and a multi-planet species, which I hope you would agree is the right way to go.”

By the way, chose ‘Allyship’ as its word of the year. The Oxford Languages chose ‘Vax,’ and Australia’s Macquarie Dictionary chose ‘Strollout’ (in recognition of the country’s slow vaccine rollout).

Did you Know? This Week in History

December 27, 1932: Radio City Music Hall Opens

At the height of the Great Depression, thousands turned out for the opening of Radio City Music Hall in New York City. Radio City Music Hall was designed as a palace for the people, a place of beauty where ordinary people could see high-quality entertainment. Since its 1932 opening, more than 300 million people have gone to Radio City to enjoy movies, stage shows, concerts and special events.

Radio City Music Hall was the brainchild of John D. Rockefeller, Jr. Rockefeller owned a $91 million mortgage on a block of real estate in Manhattan when the American economy collapsed after the 1929 stock market crash. His original plan was to build an opera house, but was eventually changed for a more “populist” option.

The famous Great Stage, measuring 60 feet wide and 100 feet long, resembles a setting sun. Its sophisticated system of hydraulic-powered elevators allowed spectacular effects in staging, and many of its original mechanisms are still in use today.

In its first four decades, Radio City Music Hall alternated as a first-run movie theater and a site for gala stage shows. More than 700 films have premiered at Radio City Music Hall since 1933, and beginning in the late 1970s, the theater changed its format and began staging concerts by popular music artists. The Radio City Music Hall Christmas Spectacular, which debuted in 1933, draws more than a million people annually. The show features the high-kicking Rockettes, a precision dance troupe that has been a staple at Radio City since the 1930s.

Weekly Focus

Being president is like running a cemetery: You’ve got a lot of people under you and nobody’s listening.

Bill Clinton, 42nd President of the United States

People say money is not the key to happiness, but I have always figured if you have enough money, you can have a key made.

Joan Rivers, Comedian