Telemus Weekly Market Review November 29th - December 3rd, 2021

This past week risk assets such as stocks and commodities continued the downward trend that began the week prior based on fears around the Omicrom variant. Measures of volatility continued to rise, with the yield curve flattening as long dated bond yields fell, while rates on short-term maturities were on the rise.

The S&P 500 finished the week -1.2% lower as investors flocked toward lower volatility sectors such as Utilities and Real Estate. Small Cap stocks, which historically exhibit higher levels of risk, fell at a more rapid pace, down -3.9%.

The bond market has been unusually erratic as rates have bobbed up and down across the curve. As the week wore on, it became clear that short-term rates were on the rise, presumably because of Fed Chairman Jerome Powell’s hawkish comments that inflation may no longer be transitory and that the central bank may need to accelerate its schedule for winding down its asset purchase program. This led some to conclude that the Fed is going to be more aggressive in the short-term, which may lead to less need to raise rates in the out years. As such, yields on longer dated maturities fell, while short-term Treasuries experienced an uptick in rates, resulting in a flattening of the yield curve. By week’s end, markets were pricing in two interest rate increases in 2022.

Adding further fuel to the fire was Friday’s employment report, which was a mixed bag as the number of job gains was lower than expected. Playing into the slower number of job gains was a sizable increase in the number of individuals that have become self-employed. Offsetting the lackluster number of job gains was an improvement in the labor participation rate along with the unemployment rate falling to 4.2%. Given where unemployment now stands, the Fed can feel more comfortable focusing more of its energy on controlling inflation, the other element of its dual mandate.

As the Fed pivots toward a more hawkish tone and now seems to be more aggressive in trying to tackle inflation, we’ve noticed more volatility in the movement of interest rates. The MOVE index, which measures volatility in the bond market, has spiked and returned to levels last seen in March of 2020. The volatility in rates has ultimately led to a flatter yield curve as short-term rates have been on the rise and long-term rates have declined. We often look at the difference in yield between a 2-year Treasury and 10-year Treasury as a gauge for the steepness of the yield curve. The spread currently stands at roughly three quarters of a percent, having dropped from over 1.5% this past spring. The drop in the difference in yield demonstrates how the curve has flatten. In fact, based on this measure, the yield curve finished the week the flattest level it’s been all year.

Looking ahead the bond market has a lot to sift through. We would expect rates on Treasuries to continue to see a higher level of volatility as the market continues to revisit its expectations around the timing of future Fed actions. Moreover, we don’t want to dismiss the fact that market sentiment will evolve as the Fed becomes less of a presence in the market. Given what are still low absolute levels of interest rates, taking extra risk to chase yield or speculate on the direction of policy does not seem prudent in our view. The level of yield currently offered in the bond market is not sufficient to compensate investors for taking on added risk.

The past year has been rather tame for the bond market. As we look ahead to a new year, we see several catalysts for added excitement and volatility. Being cognizant of interest rate risk may be of greater importance than in recent years as we seem to be embarking on tighter policy out of the Fed.

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The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 11.2 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 4.6 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization. An index is not a security in which an investment can be made, as they are unmanaged vehicles that serve as market indicators only and do not account for the deduction of management fees and/or transaction costs generally associated with investable products. The MOVE (Merrill Lynch Option Volatility Estimate) Index is a well-recognized measure of U.S. interest rate volatility that tracks the movement in U.S. Treasury yield volatility implied by current prices of one-month over-the-counter options on 2-year, 5-year, 10-year and 30-year Treasuries

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