Market Forecast For the Week of December 27, 2021: Santa Comes Out Quickly Then Returns Home As Safety Dominates The Pandemic/Holiday Season

FORECAST: The S&P 500 rises to new highs around 4830 and then begins another round of consolidation. A deeper downturn could be occasioned by geopolitical events but absent any surprises the consolidation should last some time as investors wait for more clarity on the transience of inflation as well as the efficacy of therapeutics on the Omicron variant.

Positive trends on both the inflation and COVID fronts in the past month have supported the market, as have rising earnings estimates that point to nearly 8.5% growth for the top 100 firms in the S&P 500. This in turn makes the historically high 21.5 forward PE multiple look reasonable on the assumption that inflation averages 2% over the next 5-10 years, since low inflation implies low interest rates. The Fed’s decision to quickly taper means easy liquidity will diminish to historical norms but this doesn’t imply interest rates will rise back to normal levels. The Fed is fairly confident that its combination of easy money and stringent macroprudential policies towards commercial banks is complimentary to trends in financial markets that drive efficiencies in the allocation of capital towards productive ends. This in turn drives productivity and keeps inflation from getting out of hand. A goldilocks economy with sprinkling of volatility described the American economy in the years leading up to the pandemic, and both the Fed and fixed income markets expect the same as 2022 unfurls,

Complimenting the efficiencies in financial markets are the disinflationary trends caused by the retail disruption of Amazon and the move to digitization and automation hastened by the pandemic. These trends ensure that firms emulate Wal-Mart in striving to wring out costs while simultaneously emulating Amazon by innovating to stave off the disruption wrought by small software-focused firms since the dawn of the internet. Thus the fixed-income market sees inflation as transient and it’s highly likely the Fed returns to its benign language regarding inflation in early 2022. Low interest rates are bullish undercurrent for equities, so any pullback not occasioned by a geopolitical shock will be followed by a return to market highs, allowing for trading profits.

Financial risk remains a concern but dollar shortages have eased. While China’s property crisis hasn’t triggered any fallout among global banks yet, cross-border bank claims to the non-financial private sector (e.g., real estate) are high according to the most recent BIS data. So the global financial markets need the Chinese Communist Party to finesse the troubles at Evergrande et al, which the CCP is incentivized to do since Chinese retail investors have money at stake. But overall the most recent BIS data shows a decrease in Q2 2021 of $308 billion (although due to comparisons with Q2 2020 it registered as a slight increase of 2% year on year), indicating contagion risk is now only a modest concern. EM debt repayment remains murky for badly run nations (e.g., Turkey, Argentina) but moderate global growth is buoying export confidence in major EMs. Fortunately there has been no major chatter regarding concentration risk or counterparty risk at large financial institutions.

My current market positions include a large cash position, and the following holdings: Activision (ATVI), Amgen (AMGN), American Express (AXP), Johnson & Johnson (JNJ), 3M (MMM), Titan Machinery (TITN) and a small net long position in the S&P 500 (the levered inverse ETF SPXU and levered ETF UPRO).