The Fed announced its next monetary policy move on Wednesday, December 15th. The final decisions showed that the Fed is expected to stick to a more aggressive strategy to normalize its monetary policy, as Jerome Powell characteristically stated, "Inflation is now the main obstacle of the US economy in its effort to reach the maximum employment rate and to maintain a strong long-term growth rate, as it has been doing for the last 40 years ".
The following chart is typical of the investor impasse. Pressures up to a few minutes before the announcement and then a frantic rise, which has been one of the biggest daily rises since 2020.
How did the markets go up despite the aggressive reversal of monetary policy?
It is quite possible that the majority of investors had misconceived the Fed's strategy. Investors estimated that the Fed should continue to support the economy in order to have a safety net that in turn would protect the stock market.
However, things were different. As employment still has a long way to go to reach pre-pandemic levels, while the economy continues to grow at above-average rates, the Fed must act quickly to prevent further inflation.
A clarification is needed here. The Fed refers to this part of inflation in which as a central bank it can play a role: in reducing liquidity. But there is another piece in the inflation puzzle that is beyond the reach of the Fed and has to do with the circumstances in the supply chain since the pandemic.
This is an "abnormal" situation, which is expected to normalize in the first half of 2022. When the situation returns to normal, inflation will decline significantly. To this, we must add that according to the latest data, the surplus savings of Americans, which accumulated during the pandemic, have begun to decline significantly, which means that there will be a decline in demand.
We now seem to have a first confirmation that 2022 will be another positive year for equities, because as we mentioned in a previous report, the first interest rate hikes are leading to a rise in equities as they indicate a strong economy. To be more precise, this is the Fed's bet: to be able to control inflation (where it can control it) and at the same time not allow the economy to slow down.
For now, however, according to the Fed Watch tool, the highest chances of raising interest rates are during the May 2022 meeting, where again the chances are below 50% when in the past the "certainty" was expressed in percentages of at least 70 %.
The Fed's decision on three interest rate hikes in 2022, at a time when the Omicron mutation is in full swing, clearly indicates the Fed committee's belief that this new mutation is no longer a threat to the economy and therefore no longer needs a safety net. In any case, quite pessimistic investors should keep in mind that the Fed, almost two years after the outbreak of the pandemic, has spent trillions on supporting the economy and markets and would by no means be willing to take any risk of a possible financial failure as the next bill will be much larger.
Is defense the best attack?
The current circumstances may be a cause for concern but investors see that they have no serious investment solution other than stocks. Thus, even in the days leading up to the Fed's decision, there was strong willingness to open new positions with the Utilities and Healthcare sectors hitting new highs, leading the S&P 500 into a new historical high. The technology sector is following closely and is now proving to be "all weather".
The largest technology companies have managed to uniquely integrate value characteristics at the same time with growth characteristics. On the plus side, in addition to the 5 major companies, the majority of Nasdaq stocks are in a deep bear market, which means that at the first opportunity to take a bigger risk, the Nasdaq will be in a strong uptrend. Recently, the XSpot Growth portfolio has further increased its exposure to the healthcare industry.