In the stock market, the new year may start with a bang – MarketWatch

December 20, 2021 by No Comments

Investors have had to contend with large swings in sentiment this month, capping a year of seesawing risk sentiment.

After big share-price drops in high-growth companies in the late winter and early spring, broad-based buying returned in May and the rest of the summer, followed by more selling starting in late November.

With tumultuous declines in the past month, is this a contrarian “all-clear” signal for further gains? Or, with the Federal Reserve accelerating its tapering of quantitative easing and potentially raising official interest rates in 2022, is this the end of the bull run that started in early 2020?

For answers, we look to the major players: “passive” investors and the Fed.

Passive investors never sell

Passive funds, such as exchange traded funds that invest in the S&P 500 Index
have been gaining market share for decades and are now at a critical mass of all professionally managed assets.

In recent years, traditional valuation metrics like price-to-sales and market- capitalization-to-GDP have rocketed beyond historical highs, and this is no coincidence. Passive strategies are valuation-agnostic and buy whenever new money arrives. Consistent inflows from vehicles including 401(k) retirement accounts enable constant passive buying, and this dynamic could continue and perhaps even accelerate in 2022.

Market structure suffers under the passive regime, with the same “Big 3” firms now the largest holders of nearly every U.S. company, but while this continues, it is three 800-pound gorillas competing against each other to buy U.S. stocks.

The possible cause of December volatility

RMDs could be the cause of December volatility. RMDs, or required minimum distributions, apply to anyone over age 70 1/2 who has a retirement account. As the U.S. ages, with baby boomers entering their 70s, this large demographic not only holds the bulk of the wealth in the U.S., but they are also required to sell a portion of their holdings each year.

The government waived RMDs in 2020, but they are back in 2021. RMDs negatively affect the stock market because sound financial planning calls for selling equities as you age and buying more fixed income.

Just like in 2018, when required year-end selling caused an illiquid stock market to plummet over 9% in December, RMDs may not be done wreaking havoc in 2021. The good news is, once the required selling stops, illiquid markets receiving flows can rocket upwards in the new year. In January 2019, the market recovered nearly all of December 2018’s losses. We would expect a similar dynamic to play out in January 2022 should December 2021 end with more downward …….



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