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Markets Get Nervous Again

Markets Get Nervous Again

December 02, 2021

What Santa?  No Stock Market Rally for Chrstmas?  

There is always a lot for markets to worry about.  Sometimes it seems that stocks go up even in the face of all kinds of worries.  In fact, it is rare that the average investor can’t think of a dozen good sound reasons that “now” (whenever “now” is) is a terrible time to invest.  Some in the financial world have said that making money in the stock market is all about “climbing the wall of worry”.  In other words, staying invested when your brain is screaming at you to put cash in your mattress. 

And then every once in a while, markets will suddenly take notice.  Oftentimes it is just a matter of piling one new worry on top of the already existing fears which had hitherto been seemingly ignored.   That seems to be exactly what had been taking place this week with the “Omicron variant”.  Worries about higher taxes, inflation, and higher interest rates - all very real worries - had been seemingly ignored.  Then came news of "Omicron" and all of a sudden the market has its worst week of the year.  

Society will eventually accept that Covid is just part of the landscape, and will be for a long time to come.  In comparison to governments and the general public, markets are not afraid of Covid at all.  They are afraid of expensive, wealth destroying lockdowns. (this is not a political commentary on whether or not lockdowns are necessary - but they are expensive and bad for the markets!)   And so society’s fear can infect markets when talk emerges of lockdowns, travel restrictions etc. 

Honestly, I doubt that society is going to overreact to a new variant.  There is no country on earth right now that can afford another long economic shutdown.  I think the fears are somewhat overdone.  

There are other fears however that do get my attention, and the market is now taking notice as well.  Inflation and the threat of higher interest rates is a threat that I have written about often in this space.  Increasingly, the Federal Reserve is discussing the end to “asset purchases” (call it QE, bond buying, whatever).  Frankly, its about time.  The country is awash in money, and this has helped not only create inflation, but has resulted in rapidly rising housing costs, rents, and absurd investment bubbles (Dogecoin anyone?).  Particularly worrisome is the degree to which investors (including crypto-investors) have been using borrowed money (margin). 

The excessive use of investment margin will generally result in harder, sharper crashes when markets turn south.  We have seen this play out before - in 2008, in 2018 - we don't seem to learn our lessons!  As asset prices fall, investors who have borrowed to purchase securities need to sell those investments to repay their lenders (margin calls).  Margin calls take place when the value of the "collateral" falls below a permitted percentage of total investment holdings, These essentially forced sales further downward pressure on prices, which forces more margin calls, in a vicious cycle.  The good news for long term investors is that a) margin fueled crashes tend to be steep, but recovery tends to be rapid and b) market selloffs fueled by margin calls tend to overshoot on the downside.  Painful in the short run, but oftentimes a great opportunity to rebalance or reposition a portfolio to take advantage of low stock prices.  In the event we experience an accelerated slowdown, keep in mind that the only people harmed in the long term by such a short term correction are those who are forced to sell into the chaos to pay off their margin loans.  

So right now we face dual and opposing threats.  On the one hand, an Omicron fueled economic slowdown which would cause interest rates to plunge, bonds to rally while value stocks fall and growth / tech stocks are resilient) in sort of a replay of 2020.  The other extreme would be the economy continues to strengthen and inflation persists or increases.  That would lead to the Federal Reserve cramping down on money supply and raising interest rates.  This scenario is bad for bonds, bad for expensive growth stocks, and really bad for speculative assets (like crypto).  Value stocks and dividend payers may do better. 

There is also the possibility of an in between (Goldilocks) scenario.  The economy slows just enough to take the pressure off of inflation, interest rates go up – but only modestly, and the Fed is able to gradually end its asset purchase program. 

So (as is often the case) – stocks may go up – they may go down.  Growth stocks may lead – or not.  Bonds may get clobbered by rising rates – or they will rally while stocks fall. 

The worries are all real – but the prescription remains the same.  We stay invested, we do our very best to diversify in a very challenging market, avoid taking on more risk than your financial plan can handle, and keep on climbing the “wall of worry”.