Market Commentary - Q3 2021

The US Expected an Economic Takeoff. It Got a September Slowdown.


Markets tumbled to end the third quarter of 2021, sending the S&P 500, Nasdaq, and Dow Jones to their worst monthly pullbacks since the pandemic-fueled selloff of March 2020. The S&P 500 managed to eke out a gain of 0.37% for the quarter, while the Nasdaq, and Dow lost -0.55% and -1.31% respectively.

September is typically one of the most volatile months of the year for equity markets, and this September did not disappoint. A myriad of factors contributed to the pullback including record high US inflation figures, rising interest rates, and concerns about how the gridlock in global supply chains will impact demand. After the S&P 500 rallied over 20% YTD, we would say this correction was long overdue.

Fed changes it’s tone on inflation, bond markets react

For the overwhelming majority of 2021, Fed Chairman Jerome Powell has reiterated that the rapid rise in US CPI will be transitory. Many market experts disagreed with him, including us as there are signs that while some components of CPI will be transitory, there is evidence that others components will not be as transitory.

One sure sign that inflation will be stickier than the Fed wants us to believe is that in order for employers to compete with the pandemic unemployment stimulus they are beginning to raise wages, and once wages have increased, it is extremely difficult, if not impossible for wages to come back down. Price inflation is somewhat more controllable.

On September 23, Jerome Powell changed his tune regarding the transitory nature of inflation expectations making the market jittery that the Fed will be forced to raise interest rates to combat runaway inflation sooner than expected.

Mr. Powell said that “The current inflation spike is really a consequence of supply constraints meeting very strong demand. And that is all associated with the reopening of the economy, which is a process that will have a beginning, middle and an end.”. We agree with this statement and believe that the supply chain constraints are beginning to ease.

The Fed is currently buying $120 billion a month in bond and wants that to fall to zero before it starts to raise rates. The Fed signaled it would likely start tapering those bond purchases in November, which means the process would be over by mid-2022, clearing the way for a rate increase. Half of Fed officials think rates will start rising by late next year. Just last March, a majority of officials didn’t see that happening until 2024.

Markets tend to price in events like this far in advance of policy changes and this was evident in the rise in the 10 YR US Treasury yield. The yield topped 1.5% for the first time since June. This sharp rise in rates sent the Nasdaq and other growth/tech companies into a steep sell off to end the quarter. 

The rise in yields might be taken as an encouraging sign about the prospects for the economy because yields, which rise when bond prices fall, generally tend to climb with forecasts for growth and inflation.

Many analysts, though, don’t believe that yields are rising now because much has changed about the economic trajectory. Rather, they see the bond selloff as an overdue correction to an overdone rally after the S&P 500 rose over 20% for the year. We believe that the rise in yields has been a combination of a correction after a sharp rally in equities, the announcements from the Fed, and maybe less so positive economic data. We do believe that supply chain bottlenecks will ease as the year goes on and rates will continue to rise due to an economy that can support higher interest rates. We predict that the yield on the 10 YR will finish the year more towards the high end of the spectrum between 1.75% to 2.0%.

Global supply chains come to a screeching halt

Earlier this summer, many economists saw the week of Labor Day as the moment when the economic recovery would kick into high gear. Their expectation was that widespread vaccination would ease labor shortages. Schools and offices would reopen, which would mean a comeback for local businesses reliant on office workers. Travel would rebound. Then came Delta.

The Delta variant threw a massive wrench in economic growth, pushing back the return offices from September to early 2022. This has hit some industries harder than others, especially travel and hospitality. The Delta variant also caused major supply chain disruptions that have many economists revising their Q3 GDP forecasts drastically downward. However, we are beginning to see supply chain bottlenecks ease and believe that we are finally on the other side of any Covid-19 related economic slowdowns. As a result, economists expect the recovery from the pandemic to reaccelerate in Q4 indicating that some spending and production have been delayed by the Delta surge, rather than lost to it and supply-chain disruptions.

We are beginning to see encouraging signs that supply chain constraints are easing, for example the cost of shipping a 40-foot container between China and the US (West Coast) plunged after hitting record highs in early September from $15,000 to $8,000. However, these price levels are still far above their pre-pandemic levels of around $1,500 and it will be extremely important to keep an eye on the impact of the supply chain bottleneck on consumer demand for the holiday spending season.

Oil and gas rallies to 7-year high

In an October meeting of OPEC and a Russia-led group of oil producers agreed to continue increasing production in measured steps, deciding against opening the taps more widely, and driving crude prices to their highest levels since 2014. Rises in oil prices recently had some market watchers expecting OPEC and its Russia-led allies to lift production more significantly.

Instead, the Organization of the Petroleum Exporting Countries and Russia said the group, which calls itself OPEC+, would lift its collective output by 400,000 barrels a day in monthly installments, part of a previously agreed plan to return output to pre-Covid-19 levels.

The rally in oil prices comes amid a backdrop of fast-returning demand. Economies have started humming again after near-hibernation during some of the worst periods of the pandemic. Natural-gas prices, too, have soared on higher demand and low inventories in the US and Europe.

Where are we in the business cycle?

As a continuation to our research piece and investing thesis of “Seeking opportunities in business cycles”, we believe that we are now in the mid-cycle of the business cycle, however are showing some characteristics of the late-cycle.

After we saw a record recovery in equity markets from their trough in March 2020, the US economy quickly roared through the early-cycle of the business cycle’s stages. We saw rapid expansion in GDP, employment, corporate profits, and monetary and fiscal policy. 

The mid-cycle is often the longest phase of the business cycle and displays positive but more moderate growth than the early stage. Inflation has dominated the markets and is a key characteristic of the mid to late stages of the business cycle. Some characteristics of the late-cycle are beginning to enter markets and cause headwinds for equities. These are tighter credit, rising interest rates, higher inflation, and contracting policy. We still believe the economy has not reached peak GDP as there are many parts of the economy that have not taken part in a fully reopened economy. 

During the mid and late cycles of the business cycle, between 1950-2010 equity markets still far outperformed other asset classes, especially bonds and cash. We believe that US equities still possess the highest risk/reward trade-off as bond yields should continue their upward trend, which means the prices of these bonds will continue to fall. 

How to protect against inflation and rising interest rates

There has been a tremendous amount of research in regards to investing during periods of high inflation and rising interest rates. Jeremy Siegel is a Professor of Finance at the Wharton School of the University of Pennsylvania and in his book “Stocks for the Long Run” he analyzes the returns on stocks, bonds, gold, and cash over long periods of time (from 1802 through December 2006) in both the US and other countries. The chart below is from Siegel’s research and depicts the total return indexes for these asset classes. Siegel defines total return as "all returns, such as interest and dividends and capital gains, are automatically reinvested in the assets and allowed to accumulate over time."

The clear outcome from the chart is that holding equities for the long-term are the best protection against inflation, rising interest rates, and the different stages of the business cycle.

Please  remember  that  past  performance  may  not  be  indicative  of  future  results.  Different  types  of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this newsletter (article), will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio.


We believe that US equity markets will continue to be volatile but are in the process of finding a bottom for this correction cycle. The uncertainties surrounding inflation and the impact of the supply chain on the holiday shopping period in our opinion will result in a range bound S&P 500 between 4,250 and it’s all-time-high of 4,545. We do not believe we will see a new high in equity markets until there is positive economic data regarding both inflation and supply chain constraints.

We strongly recommend that investors should stay disciplined to their long-term investing goals, with very little bonds in their portfolios as the price of these bonds is likely to fall significantly over the next 3-18 months. Investors should not react to market corrections by selling equities as we believe the long-term trend of a bull market is still intact as the economy is set to fully reopen in Q4 2021 and Q1/2 of 2022.

We believe investors should focus on large-cap equities with quality earnings, mega-cap technology companies, and industrial companies to weather the storm of rising inflation, interest rates, and a potential slowdown in the global economy.

As always, if you have any questions, or would like to discuss your portfolio/current situation, please feel free to set up a call by clicking here.

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