It proved to be a fairly choppy quarter for the U.S. equity markets. A positive start was followed by a dip mid-July coinciding with economic uncertainties brought on by the Delta variant of COVID-19. Optimism prevailed with a robust rebound, especially for the S&P 500, through the beginning of September until concerns over a number of factors surfaced, prompting a sell-off towards quarter end. This left markets close to levels three months prior, but still well up from the start of the year. Dips are common market occurrences and the current one should not cause worry for long term investors, especially at this stage of a bull market. We believe fundamentals and long term outlooks remain strong, although we remain open to opportunistic buying during any pullbacks.
The S&P 500 closed on September 30th at 4,308 representing a return of 0.59% for the third quarter, and 15.93% for the first nine months of 2021. The index continued to set new record closing highs with the latest occurring on September 2nd of 4,537. The less momentum stock heavy Dow Jones Industrial Average (DJIA) ended September at 33,844 for a return of -1.46% in the past three months and 12.12% for the year to date. It also set a fresh all-time high, closing at 35,625 on August 16th.
It is not a single event that is causing investor caution as we enter the year’s final quarter, but a confluence of factors that include the U.S. debt ceiling, infrastructure and tax bill negotiations, Federal Reserve taper talk and messaging, as well as global supply chain issues, and the potential impact of economic events in China. All of this is taking place against the backdrop of countries continuing to address the ongoing impact of COVID-19 in response to virus variants and evolving data.
Washington is currently facing a showdown in the face of the looming need to raise the nation’s statutory $28.5 trillion debt ceiling by mid-October to avoid an historic default, as well as avert an even more pressing October 1st potential partial government shutdown over funding of federal agencies. Senate Republicans are digging in their heels, resisting voting in favor of raising the ceiling as a mark of dissent with the Democrats’ agenda that included the $1.9 trillion coronavirus relief bill approved earlier this year and now the broader $3.5 trillion healthcare, climate and education bill that is being worked on.
As a stopgap measure, in the face of this showdown, going into the last week in September Senate Democrats attempted to pass a House-approved Democrat bill that would cover government funding through December 3rd, 2021 and suspend the debt limit through December 16th, 2022. This attempt was thwarted by Senate Republicans, who argue that the Democrats, as the party in power, have the ability to raise the debt limit themselves and don’t need to package it with the government funding issue. Democrats counter that under the Trump administration votes to approve raising the debt limit were bipartisan.
Democrats could present a stand-alone debt limit increase and hope that, under pressure, Republicans decline to ‘filibuster’ it in the Senate, allowing it to pass with a simple majority. Or Democrats could go the route of reconciliation, a maneuver that circumvents the Senate requirement of sixty votes to advance a bill, but Senate Majority Leader and Democrat Chuck Schumer called this difficult process “very, very risky” and a “non-starter.”
Concurrently, and as part of a negotiating balancing act, Democrat and House Speaker Nancy Pelosi prepared to back down on coupling a House vote on an earlier Senate-passed bipartisan infrastructure bill with moving forward with her party’s above-referenced social policies bill. This was seen as an acknowledgement that the $3.5 trillion package would have to be trimmed with some provisions, such as tax hikes, pared back or dropped. This stoked the ire of the more progressive members of President Biden’s government, who could move to vote down the infrastructure bill in the House in protest over an about-turn by Ms. Pelosi.
As you read this progress will, necessarily, have been made but as we write things are going down to the wire. For other nations, witnessing the debt-ceiling showdown must be a somewhat strange spectacle as the globe’s largest economy edges close to the precipice of a sovereign default (but not really).
A key component of economic stewardship in America is the Fed, and its members have had their work cut out hitting a balance between using tools to stoke the economy to achieve maximum sustainable employment (contingent on growth) while maintaining levels of price stability.
Fed officials have recently scaled back their 2021 GDP growth expectations to 5.9%, versus 7.0% in June. The inflation estimate for 2021 was raised, now 4.2% compared to 3.4% in June, but the Fed predicts this number will fall back to 2.2% in 2022 and 2023. The latest figures from the Bureau of Labor Statistics show a 5.3% annual jump in The Consumer Price Index for All Urban Consumers (CPI-U) for August, a figure three times its average for post 2008.
Fed Chair Jerome Powell acknowledged in a recent hearing before the Senate Banking Committee that “inflation is elevated and will likely remain so in coming months before moderating.” Reiterating but tempering the ‘transitory’ mantra he went on to say, in reference to price pressures and supply bottlenecks, that “these effects have been larger and longer lasting than anticipated, but they will abate.”
In conjunction, The S&P CoreLogic Case-Shiller National Home Price Index, which measures average home prices in major metropolitan areas, jumped 19.7% in the twelve months to the end of July in a market with high demand and low inventory. This figure represented the highest annual rate of growth since the index’s inception in 1987.
On the labor front the unemployment rate declined by 0.2% to 5.2 % in August and the Fed expects this to contract further to 4.8% in the fourth quarter of 2021. The end of pandemic extended benefits on Labor Day or before should encourage higher labor force participation. A shortage of workers in certain professions has certainly impacted productivity and contributed to upward wage and price pressures.
The Federal Reserve has made good on its promise to not withhold liquidity while it deems extraordinary support is necessary. It continues to purchase $120 billion a month in Treasury securities and mortgage-backed bonds to help keep longer-term interest rates low and spur more borrowing and spending. This buying spree has pushed the Fed’s balance sheet to a record high $8.4 trillion. However, following the Federal Open Market Committee’s (FOMC) September meeting, Jay Powell hinted at an imminent taper in these asset purchases with a view to possibly shuttering the program by mid-2022. In addition, nine of the eighteen-member FOMC now expect a rate hike in 2022, up from seven members in June.
Tellingly, Mr. Powell said he did not need to see a “knockout, great, super strong employment” report in October “for me to feel like that test has been met”. That test being ‘substantial further progress.’ The Central Bank’s 2% inflation target is already achieved and, barring any unforeseen derailments, employment figures should continue to improve. The general mood was that it was time for the Fed to embark on the path back towards normalization.
It is hard to imagine that normalization, however, entails much of a departure from near-zero interest rates soon since, revisiting the debt ceiling, these low rates have allowed the Federal debt to become less of a burden to service despite its ballooning balance. In 2000, American Federal debt was about a third of GDP; today that measure is around 100%. But the cost of servicing this debt is close to half of what it was twenty years ago.
Still, even talk of a rate hike, combined with a focus on inflation numbers, has pushed up fixed income yields, with the benchmark 10-year U.S. Treasury yield now above 1.5% and at its highest levels since June. This especially hit rate-sensitive technology and growth stocks toward quarter end.
Beyond our borders, this quarter marked a major milestone in U.S. foreign policy. During the early hours of the morning of August 31st in Kabul, U.S. Central Command announced the end of America’s withdrawal from Afghanistan, leaving the country under the control of the Taliban after our two decade military presence. The departure honored agreements made under President Trump and the majority of Americans think withdrawing was the correct decision or are unsure. However, the chaotic manner of the exit, hastened by the swiftness of the Taliban takeover, led to lethal situations and distressing scenes as U.S. citizens, other foreigners, and Afghan allies scrambled to evacuate. Now the question is ‘what next’? Aside from the cost of the war, America spent around $145 billion over its twenty years in Afghanistan, attempting to build a self-sustaining economy but with most money directed to infrastructure projects. The effort largely failed and the country is now potentially facing a humanitarian crisis on top of the regime change. Decisions about the extent of cooperation with the new de facto leadership will need to be made as the country’s access to foreign aid and international assets remain frozen.
There were competing claims for Afghanistan’s seat at the United Nation’s September meeting in New York, with no representative ultimately addressing the other members. Climate change emerged as one of the biggest topics at the assembly with a raft of pledges and calls to action.
The reliance on current energy sources is being acutely felt in various parts of the world at present. The U.K. is experiencing a shortage of fuel at gas stations that Britain’s transport secretary calls a “manufactured” problem due to a panic buying precipitated by a shortfall of tanker drivers. In addition, Europe is experiencing record natural gas prices as temperatures drop and Russian supplies fall. North-east China is reporting energy problems also with an electricity shortage, linked to a surge in coal prices, which has led to unplanned power cuts impacting factories and homes. In the oil market, WTI crude is close to $75 / barrel having started the year below $50 / barrel.
The financial world has been monitoring the fate of Evergrande over in China. The Hong Kong listed property giant is the country’s second largest developer and has amassed $300 billion in debt, which it is struggling to service. Concern has been voiced that a Lehman-like contagion could ensue, although the Chinese government is likely to intervene to prevent a complete collapse.
It has been a busy election calendar of late. At home, California Governor Gavin Newsom easily defeated a GOP-led recall election aimed at ousting the Democrat from office early. North of us, Justin Trudeau’s Liberal Party narrowly won Canada’s election, but failed to secure a majority of seats, which had been the aim of the early election call. Angela Merkel is preparing to step down after a sixteen-year tenure as Chancellor following Germany’s national elections. She will be widely missed, especially in Europe. Her conservative party, the Christian Democratic Union, did not fare well in the elections and parties are now negotiating to come up with a coalition government. Japan also has a new leader – Fumio Kishida, a former foreign minister, who supports a strong U.S.-Japan alliance.
Overall, the world continues to navigate towards a ‘new normal’ with the acknowledgement that Covid, and its effects on societies, will not be eradicated in the near future. The Center for Disease Control (CDC) now recommends Pfizer-BioNTech vaccine booster shots for certain groups in the U.S. including the over-65. Vaccine or testing mandates and passes are becoming more commonplace as governments and organizations attempt to mitigate spread and adverse outcomes. No single approach has proved to be a silver bullet, but our understanding about the disease and the risks it poses is now much greater.
We believe there is reason for equity market optimism looking forward based on projected economic and earnings growth, an accommodative Federal Reserve, the relative valuation of stocks versus bonds, and companies continuing to implement decisions that favor shareholders. We remain optimistic in general too, and hope you are also. As always, we greatly appreciate your continued support and trust in us as your financial advisor.
The S&P 500 is an unmanaged index of 500 widely held companies and over 80% of the U.S. equities market. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow”, is an index representing 30 companies maintained and reviewed by the editors of the Wall Street Journal. The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of the investment adviser representatives of Stolper Asset Management and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Investing involves risk and you can lose principal. There is no assurance any strategy will be successful. There is no guarantee that any forecasts made will come to pass. Past performance may not be indicative of future results. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Dividends are not guaranteed and must be authorized by the company’s board of directors.