Holiday Reflections

December 20, 2021

For many, the year-end holidays are a time to gather and savor the important things in life - family, friends, and feasts. Unfortunately, Thanksgiving was accompanied by an unwelcomed discovery, the Omicron variant, which triggered a rush to the exits in the stock market. Many stocks fell more than 10% as this latest uncertainty inspired some investors to reduce risk.

Omicron is spreading rapidly, and breakthrough infections are rising. It arrived at an already difficult time for many Western countries that were dealing with rising Delta cases. Some nations in Europe have once again turned to local and national restrictions in an effort to slow the pace of hospital admissions.

We learn more about Omicron every day. If early reports from doctors observing better outcomes in South Africa hold elsewhere, regardless of the reason (lower disease severity, vaccination, or previous infection), that is certainly good news. As the percentage of the world’s population untouched by infection or vaccination shrinks, the death toll of each wave will hopefully drop. Nothing can be stated with certainty, but hopefully our bodies and minds are learning to cope with Covid. In the investing world, fear gives way to understanding, and markets calm.

Markets are also reacting to the Fed’s pivot in response to the tight job market and higher inflation. Wednesday the Fed confirmed it would curtail its bond-buying at a faster than expected pace. It also signaled the potential for eight quarter-point interest rate increases over the next three years. That implies short-term interest rates moving back up toward 2%, but the bond market is unconvinced and is pricing in a few rate increases next year and nothing beyond that. With 10-year treasuries yielding 1.4%, bond investors are anticipating that neither inflation nor strong economic growth will persist.

As the Fed stops buying bonds, liquidity is removed from the system and there is less money for other investments – corporate bonds, stocks and so on. Some investors will sell in front of the reduced demand meaning that the adjustment to the taper has already begun.

Investing opportunities arise when perceived risk is higher than actual risk. Our portfolio holdings include businesses that would struggle in renewed lockdowns and others that would suffer with higher interest rates, but we believe many holdings should remain relatively unaffected by either. In our daily research conversations, we carefully assess the actual risks of various investments relative to what everyone else seems to be worrying about. We know we will often appear to be out of step in the short term as prices for individual stocks can move significantly higher or lower as the market’s mood changes, even though the underlying actual risks may not have changed much. Over the years, patience and persistence have paid off and we don’t see that changing.

We remain hopeful that the Omicron worst-case scenarios imagined on November 26th are now less likely, but that is far from saying it isn’t a serious concern. Although Covid’s terrible path will continue into the new year, we do believe that market participants will increasingly look past Covid in 2022. Many other issues remain unresolved. Can the Democrats eventually advance their large social and climate change spending bill (Build Back Better)? If a version similar to what passed in the House is enacted, we see both opportunity (significant tail winds for alternative energy and electric cars) and risk (how added government spending will impact inflation).