October 2021
US Economy: Growth with inflation.
Revised US GDP grew 6.7% annualized in the 2nd quarter, slightly faster than previously estimated. While consumer spending surged over the summer (+0.8% in August) measures of inflation also remained elevated. The Core PCE price index was up 3.6% on an annual basis in June, July and August.
US Stocks: Advance falters.
Large-cap stocks broke a 7-month winning streak, as Covid constrained economic activity and uncertainty over inflation and rising interest rates increased. The energy sector was the lone bright spot, gaining more than 9% in Sept. as a surge in demand boosted crude oil prices.
Foreign Stocks: China continues slide.
Foreign equities outperformed US stocks but not by much. The likely demise of Chinese real estate giant Evergrande amid no signs of a government bailout, drove Chinese stock indexes down (-5%) as well equities in China-dependent countries. Inflation, currency and political woes were added complications in Latin America (-11%).
Fixed Income: Rate rise persists.
The yield on 10-year US Treasuries is up 35 basis points since August 1. While inflation worries are a regular culprit when rates rise, this recent climb seems to be driven more by anticipation that the Fed will cut back on its market-supporting bond purchases and the political battle over the federal debt ceiling.
Real Assets: Energy boost.
Commodities led the real asset category driven by an energy shortage that forced restrictions on energy usage in China. Natural gas futures prices, up roughly 90% in Sept., have risen sharply this year as US producers hesitated in ramping up production and the summer heatwave drew down supplies.
Alternatives: Hedges work.
Hedge fund strategies didn’t all post positive returns in September, but they did hold their ground better than both traditional fixed income and equities, as managers benefited from an uptick in volatility. Among the leaders, hedge fund giant Citadel’s multi-strategy fund claimed a nearly 8% return for the month.
Equities Total Return
| SEPT | YTD | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | (4.7%) | 15.9% | 30.0% |
| U.S. Small Cap | (2.9%) | 12.4% | 47.6% |
| U.S. Growth | (5.5%) | 13.5% | 27.6% |
| U.S. Value | (3.4%) | 16.6% | 36.6% |
| Int’l Developed | (2.9%) | 8.3% | 25.7% |
| Emerging Markets | (4.0%) | (1.2%) | 18.2% |
Fixed Income Total Return
| SEPT | YTD | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | (0.9%) | (1.6%) | (0.9%) |
| TIPS | (0.7%) | 3.5% | 5.2% |
| U.S. High Yield | 0.0% | 4.7% | 11.5% |
| Int’l Developed | (2.8%) | (7.9%) | (3.9%) |
| Emerging Markets | (1.6%) | (1.2%) | 5.0% |
| Tax-Exempt | |||
| Intermediate Munis | (0.5%) | 0.3% | 1.1% |
| Munis Broad Mkt | (0.8%) | 1.0% | 3.0% |
Non-Traditional Assets Total Return
| SEPT | YTD | 1 YR | |
|---|---|---|---|
| Commodities | 5.0% | 29.1% | 42.3% |
| REITs | (5.9%) | 21.6% | 31.5% |
| Infrastructure | (1.3%) | 7.0% | 23.0% |
| Hedge Funds | |||
| Absolute Return | (0.3%) | 1.8% | 4.1% |
| Overall HF Market | (0.4%) | 3.6% | 8.9% |
| Managed Futures | 0.7% | 7.2% | 14.4% |
Economic Indicators
| SEPT-21 | MAR-21 | SEPT-20 | |
|---|---|---|---|
| Equity Volatility | 23.1 | 19.4 | 26.4 |
| Implied Inflation | 2.4% | 2.4% | 1.6% |
| Gold Spot $/OZ | $1757 | $1708 | $1886 |
| Oil ($/BBL) | $79 | $64 | $41 |
| U.S. Dollar Index | 114.1 | 113.6 | 116.6 |
Our Take
One thing that we have learned living in the Covid-19 era is that it is difficult to predict the ebb and flow of the virus. The summer resurgence in Covid would have a reasonable person expecting cases to spike as the weather cooled. Instead, both new cases and hospitalizations appear to have stabilized and even fallen in most US jurisdictions through September (to be fair, we have only just gotten into jacket weather).
While US economic growth is still generally forecasted to be robust on an absolute basis through the end of this year, expectations have fallen significantly since June. For example, the Fed has lowered its forecast for 2021 US GDP growth to 5.9% (from 7.0%) while setting the expectation that the majority of that “lost” growth in 2021 should be pushed into 2022 and 2023. It remains to be seen whether the Fed is right on this forecast. Reading the economic tea leaves is far more challenging in the current environment, which is complicated by rampant problems across the global supply chain and the blur between demand that is artificially generated through monetary and fiscal stimulus versus sustainable, organic demand.
Supporting the case for the potential continuation of US economic growth are rising incomes, the willingness of consumers to spend, and potential emergency use authorization for an anti-viral treatment from Merck, which has shown success in reducing Covid hospitalizations. But many risks remain: Accelerated inflation, rising interest rates, and supply chain disruptions are all risks we’ve identified previously and added to that list is the now familiar debt ceiling negotiation that has contributed to market jitters.
What We’re Doing
On the debt ceiling, the baseline expectation is that something will be worked out over the next few weeks because there is a political path forward to do so (i.e. through the budget reconciliation process as a last resort) and the consequences of not doing so are severe. Still, should investor perception about the possibility of a US default persist, portfolio holdings with the potential to add value in a rising rate and more volatile environment will likely benefit portfolios, namely multi-strategy fixed income and hedge funds.
The trouble with diversifying assets like those is they typically don’t look like winners when times are good. It often takes a difficult market environment to remember why we hold those positions, and recent performance might be an indicator of how such strategies can benefit portfolios when traditional assets broadly struggle.
As we approach year-end, we continue to evaluate client portfolios with an eye toward steps we can take to ease our clients’ tax burden, rebalancing portfolios to their targets as well as monitoring alignment with clients’ long-term goals and objectives.
