Third Quarter 2021 Market Recap Read
You can observe a lot just by watching. (Yogi Berra)
One of the lesser-known seasonal anomalies in the stock market is the so-called September Effect, or the tendency of stock markets in both the US and abroad to be weak during the month of September. For example, since 1928 the S&P 500 has lost 1.0% on average during the ninth month but gained 0.8% on average in the other eleven months. September 2021 fulfilled its historical destiny with the S&P 500 losing 4.65% to end a seven-month winning streak. While we’re not convinced that the Effect is anything more than a statistical fluke, some suggest psychology is at work. September marks the transition from the distracted optimism of summer to the more alert pragmatism that prevails at other times. If investors are going to be more inclined to observe, the Fourth Quarter will have no shortage of things for them to watch.
Federal Reserve Bank officials recently signaled that they are ready to begin reducing or “tapering” bond purchases. A big assumption is that inflation will prove to be “transitory” and therefore the pullback need not be hasty. However, the Fed’s balance sheet has more than doubled to over $8 trillion since the start of the pandemic, leading some to suggest that even a modest removal of support will raise rates, lower growth, and unnerve markets.
Earlier fiscal stimulus measures to mitigate the effects of the pandemic and related economic shutdown amounted to more than 26% of US GDP, close to 40% in Germany and Italy, and as much as 56% in Japan, according to Statista. Current fiscal legislation may contribute another 20%+ to US GDP, but changes to corporate, personal, and estate taxes may offset some of its effect.
In the capital markets, will bond yields finally rise to account for stronger economic growth, the specter of inflation, and Fed tapering? And will record high corporate margins stay elevated, or will wage increases, higher taxes, and supply chain disruptions cause them to fall and take stock prices with them?
The list above is long and complicated, and we haven’t even mentioned issues outside the US such as the energy crises in the UK and Europe, the related global commodity price surge, and the regulatory crackdown and real estate troubles in China. Like Berra’s quote above, the future may appear confusing and convoluted at times. However, it is through watching and observing that one acquires the knowledge needed to move forward with confidence.
We almost never think of the present, and if we do think of it, it is only to see what light it throws on our plans for the future. The present is never our end. The past and the present are our means, the future alone our end. Thus we never actually live, but hope to live, and since we are always planning how to be happy, it is inevitable that we should never be so. (Blaise Pascal 1670)
It is hard not to be impressed by the resiliency of the US economy and the speed of its recovery. US GDP growth clocked in at 6.4% on an annualized basis in the first quarter, while forecasts for the second quarter are between 9% and 10%. It is now almost certain that US GDP in total dollars exceeded pre-pandemic levels at the end of the second quarter. This is also true of the G-20 countries in aggregate. There is no doubt the keys to our success were the rapid development and deployment of multiple effective COVID-19 vaccines and effective countermeasures through monetary and fiscal stimulus. At the same time, companies and individuals adapted with a panoply of innovative technologies. Think Zoom, Slack and DoorDash!
While the economy is bouncing back rapidly, adjusting to new post-pandemic concerns will take longer. There remains a spirited debate among economists and market participants about the nature of current inflation – essentially, how long will it last and what effect will it have on the markets? A year ago, US inflation had fallen to 0.1% and the predominant concern was deflation. Today, inflation pressures are mounting as: consumers unleash pent-up demand on an economy still reeling from supply chain disruptions; the Fed continues to maintain a zero-interest-rate policy and large-scale monthly debt purchases; trillions in fiscal stimulus work through the economy; and soaring stock markets and real estate prices create wealth effects. A challenge for investors is to strip out the ‘base effects’ and temporary supply bottlenecks from more enduring drivers.
One of the more likely of these enduring drivers will be demography. According to a new book called The Great Demographic Reversal, aging populations in Developed Markets and China will have significant impacts on inflation and savings. The authors Charles Goodhart and Manoj Pradhan assert that prior decades saw the greatest positive labor supply shock in history principally as China and other emerging economies added enormous capacity to the world’s output. This increase kept wages in check and allowed for the long decline in real interest rates. These once favorable relationships are worsening quickly and inexorably. Adjustment to these ratios will play out slowly, but likely with less favorable outcomes – slower growth, higher interest rates and higher inflation. Perhaps the mantra should be to find happiness in the present moment.