Stock markets have entered the last line of the year with high multiplier levels and with an suboptimal environment as inflationary risks increase and central banks are already in the process of withdrawing from the ultra-expansionary monetary policy they have pursued since the crisis. Horizon of economic activity in the coming months.
And yet, until recently the markets have dealt with this reality successfully while continuing the uptrend trend and breaking new records. Still, something in the last two weeks has cracked, two weeks in which we have witnessed a great many surprises that have brought renewed uncertainty to the markets and the “living spirit” seems to have disappeared.
The trigger was the emergence of “Omicron” which initially led the markets to estimate that the Fed would choose to operate in the old and familiar way – “turned back” and back to providing more liquidity until the rage passed. But what actually happened? Despite the rising cloud around the horizon of economic activity, Powell came to Congress and gave a particularly “hawkish” performance when he said it was a good time to retire the word transitory when it comes to inflation. Anyone who has been following our publications for a long time has known this for many months – inflation is not really transitory and it seems that central banks are starting to be particularly stressed about this.
In other words, Powell, who knows and sees the risks to global economic activity due to governments’ response to Omicron, weighed those risks against inflationary risks and sent a clear message to the world that the Fed is expected to accelerate the end of the quantitative easing program.
Of course to surprise the markets were particularly volatile last week which led us to the weekend where we got another surprise in the form of an employment report that managed to confuse many investors. Why? In 2021, which easily gives the report the title “weak”.
However, we see that the main message from the November employment report is not in the top row but in the details and the conclusion is that the American labor market is very tight – the participation rate has risen, the unemployment rate has fallen sharply and wages continue to rise rapidly. In our view, the details of the report are only likely to reinforce the Fed’s concerns about “non-transitory” inflation.
What drives the stock market? Base data and liquidity and we seem to be entering a challenging period –
When we analyze the stock market from a 30,000-foot perspective, we look at two key vectors. The first vector is the underlying data like the corporate profits that are also reflected through the macro data, and the second vector is the liquidity determined by the central banks through the monetary policy.
Regarding the first vector, there is no doubt that the level of economic activity is still strong, but we have been seeing the slowdown around the corner for some time, whether in the weakness of private consumption or the industry affected by the continuous supply chain disruption and energy crisis. These trends in the coming months.
And that brings us to the liquidity vector – according to the book’s rules in the past, at such a time central banks tend to give more liquidity but this time central banks do not have these luxuries since inflation is high and as Powell said, it can no longer be said to be transitory. In light of this, we should not really be surprised by a weakness in the stock markets, which we believe is expected to accompany us in the coming weeks.
And it is impossible without a word about the crypto market And what happened to him over the weekend when on Saturday (they trade 24/7) the major currencies had already fallen by more than 20% but the declines moderated and Bitcoin for example ended with a decline of 12.7% “only”. It is no secret that quite a bit of crypto market trading is done with investor leverage (Margin account) which makes it a much more volatile market and particularly sensitive to high volatility in the stock markets. The rise in inflation and its significance for liquidity in the markets seems to have hit this market over the weekend as declines have apparently intensified through positions forced to quarantine in the derivatives market (margin calls). In the end, the drama in the crypto markets over the weekend is another expression of the risk-off atmosphere that has taken over the markets and it will now be interesting to see how the markets react in the opening of the week to the little drama in the crypto markets.
How is the bond market expected to respond during this challenging period?
As we keep saying, what drives the bond markets in the short parts is not really what drives the long parts and in the current and unique economic environment, it has a great many meanings.
The short parts of the yield curve are mainly affected by the direction of interest rates and inflation, but as the curve progresses, their weight decreases and the weight of the level of economic activity and the state of the stock markets increases.
On normal days, we will see a positive correlation between the inflation rate and economic activity but we are on days of slowing economic activity and accelerating inflation.
In our opinion, the uncertainty regarding the economic environment will be high in the short term in which the “Omicon” trade will dominate until it is clear how effective the vaccines and treatments are against it and how aggressive the governments will be in terms of restrictions. Such an environment together with the weakness in the stock markets is expected to support the long shekel channel and we definitely recommend increasing exposure to it.
On the other hand, high inflation and more are likely to provide us with surprises in the future, despite the drop in oil prices, just listen to what Powell has to say. In our estimation, the more volatile policy will have a negative impact on the short-term nominal channel abroad as well as in Israel. For a longer period of time than what is estimated to be what is expected to improve with the short close channel, so we recommend buying it with weakness.
.