Economic Flash: Slower Growth, Higher Inflation

November 2021

US Economy: GDP disappoints.

The US economy grew just 2.0% annualized in Q3 2021 (per GDP advance estimate), the slowest pace of the Covid recovery as a resurgence of the virus delayed the reopening of businesses, consumers dialed back spending and supply chain issues persisted. Meanwhile, headline CPI inflation is up 5.4% year-over-year.

US Stocks: October rebound.

After a roughly 5% dip for the S&P 500 in Sept., US equity markets recovered and then some with a 7% gain, the strongest monthly return of 2021 (and the best Oct. in six years) even as economic data weakened: 86% of US companies reporting for Q3 have had positive earnings surprises, despite earnings misses from Amazon and Apple.

Foreign Stocks: Inflation worries.

Non-US markets gained but lagged the US, as most nations grapple with accelerated inflation and middling economic growth. Despite strong corporate earnings abroad and lower valuations than here in the US, the focus is on potential interest rate hikes by foreign central banks and the impact on local economies/markets.

Fixed Income: Munis weaken.

Interest rates generally ended the month where they began, although foreign bond yields inched up on rising inflation. US municipal bonds also struggled somewhat as purchases have slowed to a trickle amid seasonal weakness and retail investors more worried about inflation and less about higher taxes.

Real Assets: US REITs in favor.

While commodities remain the leader in real assets year-to-date, US REITs matched the performance of the broader equity markets. Delays in “back to office” plans have been a headwind to the office sector year-to-date (+17.1%) but industrial (+40.0%) has boomed due to demand for warehouse space to store inventory.

Alternatives: Private equity boom.

Private market investments have seen tremendous interest from investors as elevated valuations in the public markets indicate more modest returns going forward. Generally strong 2021 results won’t cool off demand, but investors should remain selective in a market marked by record level of “dry powder” chasing fewer opportunities.

Equities Total Return

U.S. Large Cap 7.0% 24.0% 42.9%
U.S. Small Cap 4.3% 17.2% 50.8%
U.S. Growth 8.4% 23.0% 42.8%
U.S. Value 5.0% 22.4% 44.9%
Int’l Developed 2.5% 11.0% 34.2%
Emerging Markets 1.0% (0.3%) 17.0%

Fixed Income Total Return

U.S. Agg. Bond (0.0%) (1.6%) (0.5%)
TIPS 1.1% 4.7% 7.1%
U.S. High Yield (0.2%) 4.5% 10.7%
Int’l Developed (0.7%) (8.6%) (4.9%)
Emerging Markets (0.4%) (1.6%) 3.1%
Intermediate Munis (0.2%) 0.1% 1.1%
Munis Broad Mkt (0.1%) 0.9% 3.1%

Non-Traditional Assets Total Return

Commodities 2.6% 32.5% 43.9%
REITs 7.1% 30.2% 45.7%
Infrastructure 3.6% 10.8% 28.9%
Hedge Funds
Absolute Return 0.0% 2.0% 4.1%
Overall HF Market 0.8% 4.6% 10.0%
Managed Futures 2.5% 9.5% 16.9%

Economic Indicators

OCT-21 APR-21 OCT-20
Equity Volatility 16.3 18.6 38.0
Implied Inflation 2.6% 2.4% 1.7%
Gold Spot $/OZ $1783 $1769 $1879
Oil ($/BBL) $84 $67 $37
U.S. Dollar Index 114.0 112.4 116.0

Glossary of Indices

Our Take

As we enter the homestretch of 2021, the concerns with which we started the year remain pretty much the same. While hospitalizations due to Covid have fallen from the summer peak and more opportunities for vaccination and treatment of the virus have been approved, as many people are being hospitalized for Covid today as back in March.

It shouldn’t be surprising that US economic growth slowed in Q3 as fewer businesses reopened than generally anticipated, extended unemployment benefits dried up and consumer optimism fell. Higher inflation (transitory or not) hasn’t been a surprise either, but it is now starting to impact consumer confidence.

Spikes in the cost of energy have affected just about every sector and put a dent in consumer pocketbooks. Moreover, supply chain woes that were thought to be short-term look like they will last well into 2022. Consequently, we see inflation, especially if it is driven by an increase in input costs (cost-push inflation), as the most significant headwind to growth alongside a policy error by the Federal Reserve, which is in the unenviable position of having to support the economic recovery while keeping inflation in check. Economic growth appears poised to continue but more slowly and with a bit more downside risk.

What We’re Doing

The possibility of an inflationary environment is a factor we consider when building portfolios for clients. In fact, we regularly evaluate the risk exposures in portfolios and whether asset classes remain in proper balance. We believe we have the proper positioning currently, including investments in real assets (commodities, infrastructure, real estate) that can provide some buffer against rising inflation and market turbulence. That said, we continue to review that allocation for opportunities to improve diversification.

The rise in US Treasury bond yields has subsided, as the federal debt ceiling standoff was put off until early December. However, as the Fed begins to reduce its balance sheet in the coming months and assuming inflation doesn’t subside, it’s possible that interest rates will resume their climb. Our actively managed fixed-income positions are less tied to interest rates and should benefit in that scenario.

As we enter year-end, we continue to evaluate capital gains exposure in portfolios on case-by-case basis and adjust positioning relative to long-term target.