‘Stocks are loving the very easy monetary policy,’ says a portfolio manager
The U.S. stock market has been on a tear as it heads toward the holiday season.
“It’s a melt-up,” said Zhiwei Ren, managing director and portfolio manager at Penn Mutual Asset Management, in a phone interview. “It’s a very bizarre rally,” he said, expressing concern over the speed of the rebound from September’s pullback.
All three major U.S. stock benchmarks rose to fresh peaks Friday, marking a fifth straight week of gains for the S&P 500 SPX, +0.37%, Dow Jones Industrial Average DJIA, +0.56% and the Nasdaq Composite COMP, +0.20%.
Earlier in the week the benchmarks each notched a fourth consecutive day of all-time closing highs to mark their longest winning streak together since October 2017, according to Dow Jones Market Data. And the S&P 500 has seen just two down days in the last 18 trading sessions.
The Federal Reserve is hardly standing in the way of an ever more richly valued stock market, maintaining a loose monetary policy even with its Nov. 3 announcement that it will start winding down its quantitative easing program this year. Fed Chair Jerome Powell said the central bank can be ‘patient, but won’t hesitate’ to raise interest rates should already elevated inflation accelerate.
But some investors have worried the Fed may be behind the curve.
“The economy continues to cook, and stocks are loving the very easy monetary policy,” Paul Nolte, portfolio manager at Kingsview Investment Management, wrote in a Nov. 1 note. “The added kick from a government infrastructure bill will only add dry tinder to an already hot fire.”
The Fed doesn’t want to upset the financial markets, something that decades ago was implied but now is “explicit,” Nolte told MarketWatch by phone Friday. The central bank continues to “put money into the system” at a time of “very high” valuations in equities.
The stock market has gotten too far ahead of corporate earnings, in Nolte’s view. While “valuations are a lousy timing tool,” eventually tighter monetary policy could become a catalyst for lower stock prices, said Nolte, who believes the Fed should start raising rates at this point.
“You’ve never had economic policy this easy during an economic boom,” he said.
The Fed has kept its benchmark interest rate near zero in the economic recovery from the pandemic.
Before the pandemic, the central bank tried quantitative tightening in the fourth quarter of 2018 and announced an interest rate hike in December of that year — but the moves didn’t play out well in the stock market, recalls Nolte. It wasn’t until after Christmas that Chair Powell “reversed himself a bit,” helping to fuel a rally after stocks had dropped.
The S&P 500 tumbled about 14% during the fourth quarter of 2018, bringing the index down 6% for the year, according to FactSet data. The index then roared back 29% in 2019, climbed 16% in 2020 and has soared 25% this year through Nov. 5.
“With the S&P 500 continuing its trudge to new highs almost every day, it is clear markets are pricing in a lot of upside surprises for 2022,” wrote Nicholas Colas, co-founder of DataTrek Research, in a note emailed Nov. 2. “What makes the current environment treacherous is that stocks have been repricing fundamentals higher not just in 2021 but 2019 and 2020 as well.”
The odds of the S&P 500 returning more than 15% for three years in a row are low, at just 10%, according to DataTrek. “Getting that 4th +15 percent year on the S&P 500 is rare,” Colas wrote.
Since 1928, the S&P 500 has returned 15% for three or more consecutive years just four times, he said, linking those periods to such “overarching” market narratives as wartime spending, technological innovation and post-crisis recovery.
Colas pointed to the four-year stretch from 1942 – 1945 during World War II; the four years from 1949 – 1952 amid the post-war economic boom and Korean War; the dot-com bubble in the five years from 1995 – 1999; and the three-year period from 2012 – 2014 that followed the global financial crisis and Greek debt crisis.
“Whether you are bullish or bearish on U.S. large caps at present, there is no doubting what markets are saying as they hit new high after new high: 2022 will be another year of positive surprises,” he wrote in the note.
Meanwhile some investors expect a strong holiday season.
“Our real-time holiday sales tracker continues to show consumers are shopping at a similar pace as 2020 but higher than 2019,” BofA Global Research economists said in a Nov. 4 report.
“I got most of my Christmas shopping already done,” because of worries over supply-chain constraints, Victoria Fernandez, chief market strategist at Crossmark Global Investments, said in a phone interview. “Historically it’s a strong seasonal effect,” she said of holiday spending in the fourth quarter. “I think you’re going to see that consumer demand continue to grow this quarter, and that is going to support the economy.”
In U.S. economic data this coming week, investors will see the latest print on inflation from the consumer price index as well as a gauge of consumer sentiment.
In the meantime, “stocks have gotten a little ahead of earnings,” Fernandez cautioned. “We are by no means saying there’s nothing to worry about, go all in, and it’s going to be a joy ride all the way through the middle of next year.”
In a world of low interest rates and elevated inflation, investors have been turning to equities for returns, according to Fernandez.
Penn Mutual Asset Management’s Ren says many people are chasing returns in the stock market for fear of missing out and to preserve their purchasing power.
“There’s nothing else except the stock market at this point,” said Ren. Unless the Fed has to hike rates to tame inflation, “I think we will just stay in this high valuation world for a long time.”