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Opening Statement from the December 2021 Intelligent Investor (part 1)

Originally published on December 8, 2021

The Fed, Interest Rates, the Taper and Omicron

Over the past several weeks we have been discussing the need for the Fed to accelerate its taper schedule in order to create adequate flexibility to deal with what is beginning to look like a more prolonged inflation problem (Securities Analysis & Trading Webinars).

On November 28, Fed chairman Powell stated that inflation appears to be less transitory. Thus, he stated the Fed would consider accelerating the taper schedule first announced in November when the Fed meets on Dec 14-15.

We are concerned that the Fed might scratch plans to accelerate the taper if the Omicron variant gets out of hand. We believe the taper should be accelerated regardless how the Omicron variant plays out because inflation is becoming a significant risk. The tight labor market remains a significant problem that is not likely to go away anytime soon. Furthermore, we believe that if the Omicron variant becomes problematic it is likely to worsen supply chain problems, which will add to inflation.

We have been forecasting the possibility of a 25 basis point rate hike in 2022 for several months. We now believe there is a fair chance the Fed could raise rates twice, or by a total of 50 basis points before the end of 2022.

Part of the difficulty involved in forecasting inflation and short-term interest rates is based on the fact that inflation is in large part determined by the timing and extent of increases to the Federal funds rate (short-term interest rates). If the Fed waits too long to respond to inflation this will increase the chance of a more lasting inflationary environment and/or will lead to a more rapid pace of rate hikes.

Oil and Gas

In the November issue of the CCPM Forecaster we reminded investors of the need to factor geopolitical variables into oil pricing. This turned out to be good timing, as the U.S. announced it would release 50 million barrels of crude from its strategic petroleum reserves on November 23.

Moreover, the U.S. was able to convince several other high oil consumption nations to release some of their reserves in order to combat high energy prices. The result was a collapse in oil pricing which was further pressured by news of the Omicron coronavirus variant. In contrast, natural gas pricing soared as crude oil plummeted due to the ongoing energy crisis in Europe.

10-Year U.S. Treasury Yield and Inflation

The collapse in the 10-Year US Treasury yield during the final week of November reflected the shift by investors into risk-free bonds as they waited for more information about the Omicron variant.

Investors also moved into government bonds due to data offering more evidence that inflation is not likely to dissipate sufficiently by mid-2022, as previously expected.

Most recently investors have started to sell bonds (pushing the 10-Year yield back up) and reenter equities as the latest news on the Omicron variant is not as bad as first thought. Stay tuned because these things have a tendency to switch back and forth for a while.

Based on preliminary data, we believe supply chain issues are more severe than the risk of another economic lockdown which might come (not likely in most advanced nations, but very likely in Asia) as a result of say an out-of-control Omicron variant. Accordingly, we believe inflation is a stronger force than deflationary pressures that might arise due to continued spread of the Omicron variant.

Looking for Earnings in 2022 and Beyond

Q3 earnings growth rate came in at about 43% year-over-year. Although this final figure was a bit lower than our expectations, it was nonetheless quite impressive coming in as the third highest quarterly earnings growth rate in over ten years. As you recall, the first and second-highest growth rates were recorded in Q1 and Q2, respectively of this year. While we expected earnings growth to...