Face-Ripper Rally

The stock market gapped up at the open, following on yesterday’s recovery rally. At the moment, the Dow is up 500 points and the S&P 500 is up 2%. So we’ve filled in nearly all of the 5% Covid Omicron correction. Domestic large-caps, and especially technology, are leading the way. The VIX fear gauge fell back to 22 from a correction high of 31, and VIX January futures sank to 24. It’s looking like traders are viewing Omicron as a very temporary disruption. That seems appropriate given early indications that infections are generally not severe. But obviously we’re not out of the woods and headline risk will undoubtedly create near-term volatility. Still, we’ve seen palpable improvement in investor sentiment beginning yesterday. WTI crude oil bounced back to $72.70/barrel, and copper is up 2% over the past two days. The bond market has also shifted risk-on. Safe-haven Treasuries are in the red while high-yield corporates are rallying.

Stock market strategist Tom Lee says investors need to look past Omicron and think about what matters most to the economy and markets in 2022. Omicron is only a “flesh wound” to the economy and the recent 5% correction is only a very temporary “buyers strike.” He foresees tightening monetary policy next year as a much bigger driver of capital markets. He expects the Federal Reserve to skillfully handle the removal of stimulus and says this could mean lower inflation in 2022. Combined with solid economic growth, he sees a very positive scenario for investors. Mr. Lee is essentially describing what economists call a “soft landing” for the economy, which requires very careful fine-tuning of monetary policy to avoid a recession. It is true that many business cycles have met their end as a direct result of the Federal Reserve raising interest rates too fast and choking off credit. And that is precisely why Fed Chair Powell has been so patient and gradual in his approach to policy.

Economist and former Treasury Secretary Larry Summers takes a different view, saying that inflation has already become entrenched and the Fed will have a tough time fighting it. “The evidence is that engineering a soft landing is a very difficult thing to do in a rapidly growing, inflation economy.” This is a legitimate debate with many different views. I’ll point out some comments today by money manager and CNBC Contributor Josh Brown. His response to this question is that last week’s stock correction was “overdone” and so you should see a “face-ripper” rally this week. He doesn’t foresee any significant Fed policy mistake. He asks rhetorically (and sarcastically), “Is your base care really that the Fed is going to accelerate the taper to the point that they crash the economy? Have you been paying attention at all to everything that has been going on in the last 12 years?”  

The ISM Manufacturing index climbed to 61.1 in November vs. 61.8 in the prior month. Not only did overall business activity improve, but all of the report’s sub-components posted better than expected results. Hiring activity accelerated a bit, input cost inflation decelerated, product lead times improved, and the pace of new customer orders quickened. Goldilocks would say these results are just right. And just to be clear, ISM’s survey suggests business activity is accelerating at a near record pace.