November 2021 Stonemark Market Commentary

Following a fairly muted start to the month of November, equity markets sold off sharply in the 2nd half of November with the S&P 500 losing 1.01%, the NASDAQ falling 0.37%, the Dow Jones Industrial Average shedding 3.98%, the Russell 1000 Value lagging the major indices with a 4.24% loss & the Russell 1000 Growth being the only index to end November in positive territory with a 0.47% gain.

November proved to be quite the tumultuous month for equities with only two sectors (Information Technology +4.31% & Consumer Discretionary +0.44% for the month of November) ending the month in positive territory. On the other end of the spectrum, the Energy sector (-7.31% for the month of November) was the hardest hit as a combination of the new “Omicron” COVID-19 variant & an unusually warm start to the winter delivered a one-two punch to the Energy sector.

Following months of negotiating & both sides making some significant concession, Congress finally passed President Biden’s $1.2 trillion “Infrastructure Investment & Jobs Act” on November 5th with the House of Representatives voting 228-206 to send the bill to the president’s desk. Thirteen Republicans broke away from party lines to vote in favor of passing the massive infrastructure bill. The content of the bill, which was signed by President Biden on November 15th, did not change from the outline that we outlined in our September Monthly Commentary. As a reminder, here is what was included in the bill:

The $1.2 trillion Infrastructure Investment & Jobs Act is just half of President Biden’s spending agenda with his $2.3 trillion “Build Back Better Act” (“BBBA”) being the other component. Just a few days after President Biden signed the Infrastructure Investment & Jobs Act, the House of Representatives voted 220-213 in favor of approving the BBBA, which now sends the bill to the Senate for additional amendments. Below is an outline of the latest components of the $2.3 trillion BBBA:

Despite having the cards stacked against growth-oriented stocks (i.e. – rising interest rates, companies trading at astronomical P/E multiples, etc.), the Russell 1000 Growth extended its outperformance relative to the Russell 1000 Value by 4.71% during the month of November. Year-to-date, the Russell 1000 Growth is outperforming the Russell 1000 Value by 8.5% as of November 30th 2021. The question now is, will this trend continue or will it come to a screeching halt? Figures 1 & 2 below could provide us with some historical insight with regards to what could be in store for the equity markets in the months to come.

Before we go any further, let’s get familiar with the data that is contained in the graphics above. Figures 1 & 2 contain the same set of information, the only difference being that Figure one is from January 1st 1990-November 30th 2021 while Figure 2 is from January 1st 2021-November 30th 2021. Each “panel” (denoted by a yellow number 1-4 on the left-hand side) in the graphic above represents a different set of data for the Russell 1000 Growth & Russell 1000 Value. Panel 1 shows the actual price appreciation for the Russell 1000 Growth & Russell 1000 Value. Panel 2 indicates the percentage gain for both the Russell 1000 Growth & Russell 1000 Value. Finally, Panels 3 & 4 are the 14-day Relative Strength Index (“14-day RSI”) for the Russell 1000 Growth & Russell 1000 Value, respectively. In our March 2021 Market Commentary, we discussed what the 14-day RSI measures, but for a reminder, an RSI is a momentum indicator that is used by many market technicians to measure the magnitude of which a company or index is overbought or oversold. The RSI is displayed as an oscillator alongside a price graph of a particular stock or index & fluctuates between 0 & 100. An RSI reading above 70 is considered to be overbought while a reading below 30 is considered to be oversold. In short, a 14-day RSI uses the average gains on positive days & the average losses on negative days over that 14-day period. Because it is a “rolling” calculation, when the 14th oldest day in the calculation is over, that day is removed from the equation & the performance of the most recent trading day is then used to calculate the new average gain/loss for the new 14-day period. With this refresher in mind, let’s take a look at Figure 1.

Looking at Panels 1 & 2, prior to the divergence between the Russell 1000 Growth & Russell 1000 Value that we are currently seeing, the largest spread that we saw between these two indices was back in 2000 during the “dot-com” bubble, which we discussed in October’s Monthly Commentary. Since January 1990, the Russell 1000 Growth has outperformed the Russell 1000 Value by more than 1,200% thanks in part to the “dot-com” bubble, but more significantly, thanks to the outperformance we have seen in the last 3-4 years where the Russell 1000 Growth has outperformed the Russell 1000 Value by nearly 100% since January 2018. Turning to Panels 3 & 4, based on our understanding of RSI, both the Russell 1000 Growth & the Russell 1000 Value are sitting in somewhat neutral territory, that is, not in overbought territory but not in oversold territory either. However, going back to the beginning of 2018, the Russell 1000 Growth has spent 116 trading days above that 70 threshold that signals overbought territory compared to just 55 trading days that the Russell 1000 Value has spent in overbought territory. Furthermore, since the beginning of 2018, the Russell 1000 Growth has only spent 12 trading days in oversold territory (remember, below an RSI of 30) relative to the 30 trading days that the Russell 1000 Value has spent in oversold territory. While examining the RSI needs to be done in conjunction with analysis of several other contributing factors, such as the graphic below that shows the correlation between the Russell 1000 Growth & Russell 1000 Value relative to their respective price-to-sales ratio (“P/S ratio”).

With that being said, based solely on a technical point of view, we posit that a narrowing of the performance gap between the Russell 1000 Growth & the Russell 1000 Value could be on the horizon. From a fundamental/ratio analysis standpoint, the Russell 1000 Growth ended November with a P/S ratio of 5.49, a level not seen since the “dot-com” while the Russell 1000 Value ended November with a P/S ratio of 1.93, its highest read since the P/S ratio started being tracked. With that in mind, the current low interest rate environment, continued loose monetary policy out of the Federal Reserve (“the Fed”) & risk-on sentiment amongst investors certainly favors the growth-oriented sectors.

The day after the Thanksgiving holiday, equity markets took a beating in a shortened trading session as health officials here in the U.S. announced the first domestic case of the new “Omicron” variant of COVID-19. Originally discovered in southern Africa in mid-November, global health officials sounded the alarm by saying that the new variant had an unusually high number of mutations that might allow it to bypass the body’s natural immunity as well as vaccine-induced immunity. Towards the end of November, officials at the World Health Organization quickly labeled Omicron as a “variant of concern”, which clearly rattled the equity markets as investors were once again faced with the possibility of another round of lockdowns. Almost immediately after the WHO designated Omicron as a “variant of concern”, the U.S. imposed travel restrictions on individuals coming from Botswana, Eswatini, Lesotho, Malawi, Mozambique, Namibia, South Africa & Zimbabwe, which would require all international travelers coming to the U.S. to provide a negative test result taken no more than one day before departure. With so much still unknown about the Omicron variant, the efficacy of current vaccines & how severe of an illness Omicron will cause, equity markets are at the mercy of how investors will digest the newest developments. With the economic impact of the Omicron variant still uncertain, Goldman Sachs, in the graphic below, laid out the four scenarios that they believe are most likely.

Downside Scenario: Omicron transmits more quickly than Delta, and evades immunity from vaccines and prior infections. In this case, Omicron unseats Delta as the dominant strain, as well as "evades immunity against hospitalizations only slightly more than Delta, and causes similarly severe disease." As far as economic impact, it would result in another large Q1 infection wave across various economies, resulting in a global growth slowdown to a 2% q/q annual rate - 2.5pp below Goldman's current forecast.

'Severe Downside' Scenario: This less likely scenario would see both disease severity and immunity against hospitalizations substantially worse than with Delta, and would have a worse economic impact than the 1st scenario. The economic impact would of course be worse, while "The net overall inflation impact is again ambiguous although the moves in energy and services inflation(down) and in goods inflation (up) are larger."

False Alarm Scenario: Omicron is a nothingburger - and spreads more slowly than Delta. It has no significant effects on global growth and inflation. In this scenario, the sharp rise in reported Omicron cases in Gauteng may reflect skewed sequencing, other data issues, or superspreading events. Finally, any ability of Omicron to outcompete Delta in South Africa does not necessarily carry over to other geographies with higher vaccination/lower prior infection rates.

Upside Scenario: Here, Omicron is slightly more transmissible than Delta but causes much less severe disease. This speculative 'normalization' scenario would result in a net reduction in disease burden on various systems, leaving growth higher than in Goldman's baseline. In this scenario, inflation is likely to decline more quickly than the baseline scenario because of a rebalancing of demand from goods to services, along with an accelerated recovery in goods and labor supply. 

While the economic impact of this “4th wave” of COVID-19 remains to be seen, initial indications with regards to the transmissibility & severity of illness of the Omicron variant have health officials cautiously optimistic that this isn’t as severe as the Delta variant. While Omicron appears to be much more transmissible than previous variants, individuals who have tested positive for Omicron have reported much milder symptoms, which has led to some health officials saying this could be the best-case scenario for ending the pandemic. If Omicron is indeed more transmissible but much less severe in terms of its symptoms than previous variants, those optimistic health officials have suggested that this could become the dominant strain & could be the key to ending this two-year long pandemic. However, if the last two years has taught us anything, it is that we should hope for the best but plan for the worst. With that said, we will continue to monitor any developments surrounding the Omicron variant & will make changes to our portfolios as necessary.

As we enter the final month of 2021, our focus is going to start to shift towards planning for what 2022 might have in store for the markets. Arguably the largest potential catalyst to keep an eye on in 2022 is going to be the Fed & what sort of monetary policy changes they plan to make. As it stands today, the CME Group’s “FedWatch Tool” is pricing in two interest rate hikes, which would bring the Fed Funds Rate to the 0.50%-0.75% range. While this is still well below the targeted long-term Fed Funds Rate of 2.5%, it is still two interest rate hikes following almost two years of historically low interest rates. As a result, the previously-mentioned growth v.s value divergence that we have continued to see, could come to a screeching halt in 2022. In addition to potential moves from the Fed, we will also be keeping an eye on Capitol Hill & developments surrounding President Biden’s Build Back Better Act & corresponding plans to fund this policy (read – tax hikes). With several market-moving catalysts on the horizon in 2022, we will remain diligent when it comes to positioning our portfolios. Whether that requires us to raise our cash levels or implement some sort of hedging position in the event of a market downturn or deploying some of the cash that we have raised over the last few months in the event that 2022 continues the strong market performance that we have seen in 2021, we have the tools at our disposal to do so. Finally, we will continue to keep everyone up to date on any developments that warrant bringing to your attention.

As always, please feel free to reach out with any questions or concerns.

Stay Safe & Stay Healthy!