Market Strategy 11/22/2021

Key Takeaways

• With 475 or 95% of the companies in the S&P 500 index having reported, earnings are up 41% from a year earlier on revenue growth of 17.7%. At this late point in the season, 81% of firms have beaten analyst estimates.
• We share our views on the potential re-nomination of Federal Reserve Chair Jerome Powell, versus a change in leadership at the Fed.
• We also discuss the challenges faced by the Senate in negotiating the fate of the $1.7 trillion spending measure approved by the House last week and investors’ concerns about direct exposure to China’s publically traded corporations.
• Data released last week showed retail sales up sharply in October led by online retailers; this is perhaps indicative of an early holiday shopping season. 

This week will likely find investors sharply focused on the President’s decision as to whom he will nominate to lead the Federal Reserve in the new term that begins in February. At the end of last week the President had indicated that his decision had narrowed to the current Fed Chair Jerome Powell and Fed Governor Lael Brainard. He added that his decision was imminent and likely to be announced within four days. As of the weekend some pundits postulated that the President might postpone making his decision until after Thanksgiving if to avoid any indigestion the market might undergo whether he decides on one or the other candidate.

With the passage by the House on Capitol Hill of what CNBC news described in a “CNBC Politics Editor’s Note” last Thursday as “President Biden’s elephantine social safety net and climate change package”, this week will no doubt also find investors (constituents of either side of the political aisle) glued to the news channels for developments in the arguments and negotiations about to begin in earnest as the Senate considers the fate of said package.

In our meetings last week the three most asked questions were tied to the nomination of the Fed Chair; the outcome of the $1.75 trillion bill just passed on Thursday by the House; as well as questions about China, its economy and the ramifications for investors of recent policy changes by China’s regulators and policy makers toward China’s publicly listed companies.

Our answers:

We’ll start with the FED nomination:

As to which of the two candidates the President might select we expect the decision will come down to a near photo finish with both candidates being experienced Federal Reserve officials whose thinking and approach to issues the Federal Reserve considers on a day to day basis are well known to economists at the Federal Reserve as well as those found on Wall Street and Main Street.

That said, in our view should the President decide to nominate current Fed Chair Jerome Powell it could avoid what we have come to recognize as a period of uneasiness the markets can exhibit in the first year of a new chair person’s ascendancy.

In our view President Obama during his presidency astutely avoided adding a level of uncertainty as the country was working toward exiting the Great Financial Crisis when he nominated Fed Chair Bernanke to a second term. Ben Bernanke had been nominated for his first term by President George W. Bush, a Republican, and had led the Federal Reserve in navigating the economy out of the Crisis from the depths of 2008.

In our experience over the past 38 years in the financial markets we have found that the markets in dealing with a new chair at the Fed often react like the loyal family dog that mistrusts a new guest in the family household until that guest proves to be a friend and not a foe. We recall that President Donald Trump did not nominate Janet Yellen for a second term to the Fed chair and the subsequent turbulent period which followed in 2018 through near the end of the fourth quarter of that year as market participants adjusted to the leadership and style of the then new chair Jerome Powell.

Since 2018 the markets have grown in our view accustomed to the leadership of Fed Chair Jerome Powell offering something for President Biden to consider.

We’d suggest that the precedent set by President Obama in nominating Ben Bernanke could well prove a practical decision for President Biden to consider with the economy in the process of re-opening at its broadest levels since 2020 and with a fourth wave of the pandemic on the wing in Europe and elsewhere around the globe.

In consideration of the outsized levels of stimulus already added to the US economy by both the Trump administration and thus far by the Biden administration in dealing with the pandemic as well—as in recognition of the current high levels of inflation being experienced stateside—we’d hope that what is likely to be a hard negotiation process ahead on Capitol Hill will find an outcome that considers the additional costs to the deficit outlined by the recent study by the CBO (Congressional Budget Office). Also we’d hope that the risk of costly inefficiencies that can occur with outsized government programs along with the prudence of “keeping some powder dry” for challenges that could emerge in the months ahead would be taken into consideration.

There’s no easy task ahead for politicians in Washington and likely a potential source of volatility as market participants belonging to both sides of the political aisle ponder the outcome of the decision at hand.

The changes in policy by China since the ascendancy of President Xi Jingping in November of 2012 have been increasingly dramatic year to year from a perspective of geopolitics and that country’s domestic economic policy. Over the course of the past year or so changes and developments in policy objectives that affect China’s publicly traded technology, for-profit-education and property companies among others have raised concern among US and other foreign investors as to the risk the changes in policy have attached to investments in China’s publicly traded companies.

Stocks of companies domiciled in China and traded around the world have experienced increased volatility as a result of changes in policy by China’s officials. Some foreign investors have opted to reduce and even eliminate exposure to China as the process of change in policy has taken place. Others have taken on additional exposure to China as they see the current volatility in China’s equity markets as an opportunity to buy stocks on the cheap.

We suggest as we always do that investors know what they own, understand their tolerance of risk and have right-sized expectations of how their investments will perform in different scenarios.

In core diversified portfolios which the Market Strategy team manages we have significantly reduced our direct exposure to companies based in China while increasing exposure to other emerging equity markets. We recognize that in a world in which the global supply chain persists “one country centric” all roads (and nearly most asset classes) lead to exposure to China in some way.

While China’s economy has slowed as most other economies have in the process of navigating the pandemic the country’s rate of growth relative to its economic position and size will likely continue to grow competitively in what is expected to be a post pandemic “endemic next new normal.”