A “One-Two” punch of major headlines recently hit the markets, causing a liquidation event. In a previous perspective, we analyzed the strong performance of risk assets. The Russell 2000 (Symbol: IWM) tracking ETF was breaking above a 9-month consolidation range, multiple commodity market segments were setting up for a potential move higher, and the crypto-currencies were setting new highs. However, starting the week of Thanksgiving, major headlines quickly shifted the tone for “risk-on” assets.

The initial punch was the announcement of the Omicron strain the Friday following Thanksgiving, which ignited fear in investors that the new strain could cripple global economic growth.

Next, Federal Reserve Chairman Powell changed his tone on inflation. Investors focus on keywords in Fed commentary, and the term “transitory” has been removed from many of Powell’s remarks in recent weeks. Now that the Fed is committed to fighting inflation with a more persistent outlook, interest rates could rise earlier and with more velocity than expected. This could put pressure on the consumer (home and auto loans) and corporations with excessive debt on their balance sheet.

Finally, on the commodity front, the U.S. released oil from its emergency reserves in recent weeks. This action was aimed to combat higher oil prices since OPEC initially refused to increase production. It was the first time in U.S. history that emergency reserves were used to fight inflation by possibly lowering the price of oil and therefore gas prices. Prior releases were because of natural disasters.

G&S Perspective: 

We believe the current market behavior has more to do with a shifting Fed policy than the new Covid variant. So far the market is adjusting okay to the Fed’s comments towards inflation, taper, and eventual rate hikes, but we will find out at today’s Fed meeting if Powell is able to keep investors calmly in their chairs.

As of now, none of this necessarily changes the bullish tone of the broad market but should be a warning that stocks trading at high valuations are vulnerable to quick pullbacks.

Light Crude Oil

Chart Source: StockCharts.com

S&P 500 vs. Russell 2000 Comparison

Chart Source: StockCharts.com

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