Q3 2021 - Shifting Sands

Despite a myriad of concerns regarding inflation, Covid variants, Chinese regulation, and tax reform, the market remains resilient. We applaud market participants' ability to focus on positive trends, including a healthy U.S. consumer, robust corporate earnings growth, and low interest rates. The early part of the quarter was relatively uneventful with markets continuing higher, but September was a much different story. Chinese debt concerns and legislative haggling in Washington caused the market to pause in the final few weeks of September. The S&P 500 and the technology heavy NASDAQ took a breather in the third quarter with a +0.58% and  -0.22% return, respectively; but remains positive double digits for the year. While earnings growth surprised to the upside in the second quarter, the actual results exceeded the most bullish of expectations. Inevitably, future growth rates will slowly decline to a more normal trend. Investors should not only focus on corporate earnings growth, but the clarity businesses are providing regarding inflationary pressures, profit margins and forward guidance.

 

On the economic front, the August employment report was mixed, showing an addition of only 235,000 jobs added to the economy. This was significantly lower than expected and is clearly the result of labor supply shortages as opposed to a lack of demand. It is important to note, the labor force participation rate is lodged at 61.70%, which is only 1.50 points higher than its April 2020 multi-decade low. Ultimately, the combination of the expiration of enhanced unemployment benefits and higher wage growth, will increase labor supply. The labor market finds itself with over 10 million job openings and businesses across several sectors of the economy are finding it challenging to hire good talent. On a positive note, the unemployment rate is trending in the right direction, falling to 5.20% compared to the 5.80% witnessed in the second quarter. With the most recent GDP report displaying an annualized growth rate of 6.50%, the economy has officially surpassed the pre-pandemic level despite a labor market that has not rebounded to its full potential.

 

Fixed income is on an entirely different path compared to equities, as it has remained relatively flat since mid-2020. The price performance component for bonds is facing headwinds from interest rates being higher than they were at this point last year. High-yield and corporate investment grade bonds have fared slightly better as economic data has improved, but overall performance has been rather subdued.  Longer-term U.S. treasury yields have risen from multi-month lows, but still far behind the highs reached earlier in the year. The 10-year treasury rate ended the quarter at 1.49%, just 2 basis points higher from last quarter. While we expect rates to be generally higher at year end, in our view, the tapering of the Federal Reserve's monthly bond purchases is not likely to be a major driver for interest rates since it is already anticipated. Foreign bonds were down -0.15% for the quarter, while the performance of the Barclays Aggregate Bond index was slightly better for the quarter with a +0.05% return.

 

Contrary to U.S. strength, emerging market stocks experienced a correction in the early part of the quarter. This precipitous decline was led by Chinese stocks due to the Evergrande fallout, ongoing government intervention and regulation for businesses that operate in private education, data privacy and protection, online gaming, and technology platforms. Chinese companies represent roughly a third of the emerging market index. At a minimum, investing in China has become more complex as investors must now weigh the extent to which a particular business aligns with the policy objectives of the Chinese government. Despite the volatility witnessed in emerging markets, foreign developed markets marched higher due to corporate earnings and hopes that central banks' accommodative policies and Covid vaccination programs will continue to support an economic recovery. International markets underperformed their domestic peers. The MSCI ACWI ex-US index returned -2.99% for the quarter and the MSCI EAFE index returned -0.35% for the quarter.

 

THOUGHTS ON ASSET ALLOCATION

 

Historically, autumn is known to produce market volatility. However, we remain confident that the economy will move forward at a modest pace and inflation pressures will slowly moderate. Our Investment Committee continues to monitor the expiration of pandemic related consumer support and the risk that Covid variants become more disruptive. However, we believe that the resolution of supply chain disruptions and dissipation of inflation base effects will mitigate economic and inflation risks. Our Investment Committee has begun active discussions regarding positioning and rebalancing for the new year and will look to make changes in our December meeting.

Our Investment Committee believes that our current managers are poised to benefit from long-term and attractive investment themes. Listed below is a subset of our equity and fixed income managers that performed exceptionally well versus their stated benchmarks in the third quarter.

 

 

We look forward to speaking with each of you regarding our views and the performance of your respective portfolios. For additional information or questions please contact Mason Williams, Chief Investment Officer, at 786-497-1214 or Michael Unger, Investment Officer, at 786-292-0310