As 2021 comes to a close -- a full two years after the pandemic started -- the S&P 500 makes its way to new all-time highs. It's up 200% plus since the lows reached in March 2020. When one looks back at the speed and intensity of the recovery, it is remarkable. But if one were to just look at the index, it really does not explain the entire story.
According the note out by Goldman Sachs (GS) today, if one were to allocate $1 into the S&P fund (SPY) ; 6.3 cents would go to Microsoft (MSFT) ; 6 cents to Apple (AAPL) ; 4.4 cents to Alphabet (GOOG) / (GOOGL) ; 4 cents to Amazon (AMZN) , 2 cents to Tesla (TSLA) ; and 2 cents to the former Facebook, Meta (FB) . Essentially 25 cents of every dollar in "equity allocation" goes into these six stocks, with Apple now larger than Germany.
The market really is a tale of six stocks and the rest, so it's important to look at each sector underneath the hood to truly understand the market performance and mood.
The more pertinent question on everyone's mind after two years of pandemic-induced monetary and fiscal easing is why does the Fed still need to buy up to $120 billion in asset purchases when we have almost reached full employment with jobless claims hitting all-time lows and markets at all-time highs. The Fed's balance sheet is close to $9 trillion now, increasing about $4.5 trillion in just two years, and yet the Fed feels the need to keep buying assets.
Initially, the Fed had a dual mandate: to get employment growth to pre-Covid levels and inflation moderating at around 2%. The problem with this dual mandate is that the economy is now seeing the lowest jobless claims in 52 years, and the participation rate cannot move higher as a subset of people have permanently retired, possibly after trading bitcoin with the Fed stimulus checks -- so it is not entirely clear whether the Fed will ever reach their full employment target.
Inflation, on the other hand, has moved above and beyond the Fed's target. We are close to averaging 6.5% year-over-year on the consumer price index, according to the November data. That's the highest level since 1982. The Fed can keep on reiterating that inflation is "transitory," which in its defense might be true, but it all depends on how one defines transitory. If inflation were to persist for one to two years, that could still be considered transitory, if one were to look at a 10-year time frame. The fact is, there is a secular shift higher in inflation as seen by the stickier components of the CPI, rent inflation, used car prices, energy costs, and, now wage, inflation.
Over the last decade, the Fed has always reacted to any problem by printing even more money. That worked well when inflation was close to 0% and balance sheet only $1 trillion to $2 trillion. Now, the Fed is in a bit of a catch-22 situation whereby if there are any hiccups in the economy, it cannot print its way out of the problem as inflation will sky rocket even further. And, if the Fed raises rates or tapers a lot more aggressively, this entire system, which is built on a tower of liquidity, is at risk of falling down. This is what the Fed is most afraid of. Whether we like to admit it or not, this entire market has been driven by all the liquidity that has been fed to it over the past decade.
The Fed, as always, is in a wait and see, or rather full of hope, mode, as it has no margin of error to accomplish anything. The only one option it has, which is to tighten, is at risk of crumbling the system, no matter how much it is needed. Investors are so conditioned to buying the dip, as they have been trained for the last 12 years, given the existence of the Fed put. The only question is, how far down is that Fed put today, given the debt and inflation in the system?
Perhaps the strike is not as high up as most think.
