This week, CIO Tom Weary, CFA®️, discusses the rapid spread of the Omicron variant, the strategy shift indicated by the latest meeting of the Fed, and the latest earnings report from RFA portfolio holding Nike.

Transcript

Hi, I’m Tom Weary here at Reilly Financial Advisors with your Weekly Market Update. Since our last update, stock prices have been whipsawed by each new headline regarding the Omicron variant of coronavirus. We have also had some eye-grabbing numbers regarding inflation, a Fed meeting which charted a new course, and even some earnings reports from a few of our companies. But first, let’s start by looking at the latest news regarding Omicron since the pandemic continues to drive the investment narrative.

As we can see in this first chart, daily cases of COVID-19 had been trending upwards rapidly in recent weeks, most likely due to a combination of the highly transmissible Delta variant and Thanksgiving travel and gatherings.  We were headed towards a challenging winter even before the emergence of the much more virulent Omicron variant.  As you can see in this second chart, Omicron has quickly displaced Delta as the leading variant of coronavirus. Just two weeks ago, Delta represented 87% of new coronavirus cases while Omicron represented 13%. Last week, however, Omicron represented 73% of COVID-19 cases while Delta represented 27%. In some areas of the country, Omicron now represents over 90% of new coronavirus cases.  The Omicron variant is causing COVID-19 cases to double every one and a half to three days in places with community transmission. The variant is spreading rapidly even in places with high levels of immunity in the population. The National Football League has already been forced to re-arrange game schedules due to outbreaks of COVID, while National Hockey League players joined the New York Radio City Music Hall Rockettes in taking the rest of the year off. Clearly, Omicron is having a large and immediate impact. Stay tuned.

As you may know, the Federal Reserve is charged with a dual mandate of running monetary policy consistent with both full employment and stable prices. Ever since the beginning of the pandemic, they have tilted heavily towards running the economy hotter in order to support employment.  They have done this by immediately cutting interest rates to zero while engaging in massive Quantitative Easing through large monthly purchases of Treasury bonds and mortgage securities.  Recent data strongly suggest that they should tilt monetary policy in a different direction. As you can see in this first chart, November unemployment surprised economists by coming in at only 4.2%, near an historic low. A few days later, the Job Openings and Labor Turnover Survey surprised with the record number of job openings, which now exceed 11 million. Perhaps an even stronger proof of full employment from the JOLTS was the Quits rate, or number of employees willingly leaving their jobs, most likely to take another.  As we see in this next chart, the Quits rate hit an all-time record.  Clearly, the jobs market is very, very strong.

At the same time, inflation readings are grabbing ever more attention. As you can see in this first chart, headline CPI for November came in at 6.8%, the highest reading in 40 years. Even stripping out the volatile food and energy sectors, as you can see in this next chart, core CPI came in at a still high 4.9%. And things are no better for producers. As you can see in this next chart, the Producer Price Index for November came in at nearly 10%, while stripping out food and energy led to a core PPI increase of 7.7%. This is against the backdrop of a very strong domestic economy, with headlines of U.S. service sector activity hitting record highs in November. As you can see in this next chart, the Institute of Supply Management reported the November Purchasing Managers Index at a surprising 69.1, well above recent levels. Keep in mind that the services sector represents 70% of GDP. And things are very strong over on the corporate investment side as well, as we can see in this next chart of capital goods new orders nondefense ex aircraft, or private corporate investment, hitting new highs.  Time for the Fed to take their foot off the gas pedal.

All of these indications of economic strength led the Federal Reserve to announce at their most recent meeting that they will be doubling the rate at which they taper down quantitative easing, implying that they will stop buying new bonds by March. Their own economic forecasts indicate that they expect to hike the federal funds rate three times in 2022 once they have completed quantitative easing. However as this last chart indicates, market participants are not convinced, expecting only two rate hikes, with the first in may and the second in September. The Fed is very data driven, so we will have to see how the data unfold.

After the close on Monday, Nike, a holding in both Core and Defensive portfolios, reported yet another blockbuster quarter.  Nike posted fiscal second quarter earnings and sales that topped analysts’ expectations despite persistent supply chain challenges. The company reported earnings of $1.3 billion, or $0.83 a share up from $0.78 a share a year ago. That beat analysts’ estimates of $0.63 by 20 cents. Revenue rose to $11.4 billion from $11.2 billion in the year ago quarter.  Revenue in North America, Nike’s biggest market, climbed 12%, representing the highest growth of all geographies. Greater consumer demand, especially for online merchandise, helped boost results. Nike digital grew 11% in the quarter and now accounts for 25% of its total revenue globally. The company previously detailed issues with making its products in Vietnam amid a spike in the coronavirus in that country that forced factories to shut down, as well as increasing costs for delivering its goods and paying workers. The great companies always find ways to work through great challenges.

So, what does it all mean? The pandemic continues to drive the investment narrative with the Omicron variant now providing a new storyline to follow. Data suggest that the domestic economy is so strong that the Fed must now shift its emphasis away from supporting the jobs market and focus on regaining price stability. There are some concerns that the emergence of the Omicron variant will both increase inflationary pressures on the supply chain while at the same time weakening the economy. Certainly bond investors are not concerned about inflation getting out of hand, with the 10-year U.S. Treasury yield falling below 1.5% as the yield curve flattens, suggesting weakening economic growth ahead. Even in these challenging times, great companies such as Nike find ways not only to survive , but to thrive.  We will keep our eyes on the data as it emerges, while hoping that you can enjoy the holiday season. So sit back, relax, have a very Merry Christmas, and join us again for the next Weekly Market Update.

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