While there may be a pause in economic activity, a pull-back seems unlikely; consumer finances remain solid, inventories are low and need to be rebuilt, and capital spending looks set to accelerate in 2022.
David M. Lebovitz
Global Market Strategist
Listen to On the Minds of Investors
Late last week, reports of a new COVID variant began to dominate the headlines, leading investors to question whether vaccines would be effective against this variant and the impact it could have on the economy and corporate profits. While it seems unlikely that we are headed back into a full lockdown, we could very well see the revival of mask requirements and social distancing over the coming weeks. Importantly, there is much we do not know about this mutated version of the virus; what we do know is that the virus will continue to mutate as long as global vaccination rates and immunity remain low.
Markets, however, have decided to shoot first and ask questions later. Volatility has come roaring back, with the S&P 500 seeing its worst 2-day performance in over a year and the VIX back above 30 for the first time since February. While some of this is undoubtedly due to concerns about the virus, recent commentary from Chairman Powell has contributed to market stress.
During his testimony before Congress, Powell suggested that inflation was no longer transitory and that the pace of tapering might be accelerated at the FOMC’s December meeting. However, tapering is different from tightening, and the Fed’s desire to increase the pace of tapering seems linked to concerns about financial markets overheating. As such, tapering may conclude earlier than expected, but we struggle to see how the Fed will raise rates before late 2022/early 2023. The icing on the volatility cake has been the issue of the debt ceiling, although Congress did strike a last-minute deal on Friday to prevent a government shutdown.
These developments have left the yield curve at its flattest level since the beginning of the year, which has naturally translated into conversations around a Fed policy error and the potential for a recession. While there may be a pause in economic activity, a pull-back seems unlikely; consumer finances remain solid, inventories are low and need to be rebuilt, and capital spending looks set to accelerate in 2022.
Markets discount information, and right now, there is limited visibility as to what may lie ahead. This has led to a wider distribution of outcomes, and a subsequent rise in volatility. However, with economic fundamentals still intact and corporate profits set to grow further next year, we continue to embrace risk assets in portfolios. That said, we recognize that this recent uptick in volatility may not dissipate anytime soon, suggesting a balanced approach to investing remains of the utmost importance.
Equity volatility now catching up with rate volatility
Implied volatility, indexed to 1 at start of 2021, daily
Source: CBOE, ICE BofA, J.P. Morgan Index Research, FactSet, J.P. Morgan Asset Management. Equity volatility is represented by the VIX Index, interest rate volatility is represented by the MOVE Index and foreign exchange volatility is represented by the J.P. Morgan Global FX Volatility Index. Data is based on availability as of December 1, 2021.