Markets clearly lost momentum in September as stocks stumbled into the end of the quarter. While markets and economic growth regularly face challenges, 3rd quarter seemed to be more difficult than usual. The weight of these challenges eventually caused the amazing 17-month rally that followed the March 2020 selloff to get wobbly. Government policy decisions including the Federal Reserve possibly tapering its bond purchase program earlier than expected and nearly two years of the ongoing pandemic continue to play significant roles in shaping markets and economic growth.
The Pandemic Rolls On
At the end of the 2nd quarter, pandemic news had faded to the background and it appeared this difficult period for the country and globally was becoming less of a challenge for the economy, markets, and policy makers. And then, in a relatively short period of time, surge number four was upon us. While the human aspect of this surge was just as tragic as the others, the impact to markets and economic growth this time were clearly more muted. Empowered with a large segment of the population being vaccinated, the political will to enact severe restrictions on social and business activity generally was lacking.
Additionally, COVID fatigue was evident among many as social interaction and travel slowed some as case counts grew, but clearly individuals are anxious to get back to their old lives. While economic growth was likely impacted, 3rd quarter U.S. economic growth likely will be well above historical trends.
Policy Debates Roil Markets
A number of legislative issues are converging in Congress: The federal debt ceiling, the bipartisan infrastructure bill, and the $3.5 trillion spending and taxation plan advanced by the White House. These issues have become so intertwined that resolution of each depends on the outcome of the others. The possible legislative outcomes have become very murky and the looming, but very unlikely, U.S. default without an increase to the debt ceiling will further amp up the drama and tension. This uncertainty on taxation and government spending will continue to simmer in the background possibly causing continued volatility in markets until some resolution is reached.
Glimmers of Hope
While my opening comments seem rather gloomy, there are many positives worth noting. Labor markets and the economy continue to be very healthy. The outsized growth rates experienced by U.S. companies in the first two quarters of 2021 have led to healthier balance sheets and mountains of cash.
Additionally, despite a fair amount of controversy regarding vaccines, more than 55% of the U.S. population has been vaccinated. While there have been breakthrough cases, evidence continues to indicate reduced hospitalizations and fatalities for those that are vaccinated versus those that aren’t. As case counts and hospitalizations decline as we enter the 4th quarter, hope for life returning to ‘normal’ for 2022 seems like a real possibility.
Additional Q3 Highlights
ECONOMY: As the 3rd quarter began, the U.S. economy was riding a powerful wave of growth propelled by massive federal stimulus enacted earlier this year. Markets and economists expected this wave of growth to continue through year end as many forecasters projected 7-8% Real GDP growth rates for 3Q21 through August. By early September however, it became clear that the COVID Delta variant was disrupting economic activity, despite determination from the country at large to re-open and get back to a semblance of normalcy. Layer in supply chain frictions and product / labor shortages in some industries, expectations for 3Q21 U.S. Real GDP were marked down sharply in September, with the latest updates in the Bloomberg Survey projecting 4.5% Q/Q AR growth in the quarter. While down from expectations, 4-5% growth is a continuation of a strong economic recovery.
EQUITIES: Equity markets peaked during the third quarter and volatility, especially of the downside variety, accelerated. Investors have chosen to become more risk-aware of late and elected in September to trim exposures to very richly valued stocks. Domestically, the September swoon was widespread and all of the major style/size combinations of stocks posted negative results, and most did so for the quarter as well. Internationally, negative results were also widespread with a few minor exceptions. The decline in September is the likely result of growing investor discomfort with an expanding list of threats to their serenity including the looming transition from a peak growth environment to a more mature part of the cycle within the context of very high stock valuations.
FIXED INCOME: The U.S. bond market during the third quarter of 2021 was a challenging period even for the most seasoned investor. Strong but decelerating economic growth, spiking inflation, mushrooming government budget debt and deficits and transitioning central bank policies were but a few of the factors investors were forced to handicap during the quarter. For the 3rd quarter the bellwether U.S. Treasury 10 year yield finished just slightly higher to 1.49% but only after dipping as low as 1.12% in August. As a result, most high quality bond indices generated near breakeven quarterly total returns.
POLITICS AND POLICY: Progressive House Democrats have vowed to vote against the $1.2 trillion infrastructure bill passed earlier this year by the Senate until more action is taken on a proposed $3.5 trillion spending/taxation plan that would fund other priorities that President Joe Biden laid out earlier in the year. Democratic leadership hopes to pass this legislation on a party-line basis via budget reconciliation but fissures within the party have become very clear and passage of any legislation looks less certain.
Also looming is the ongoing standoff on the federal debt ceiling. A suspension of the debt ceiling expired on July 31, prohibiting the U.S. Treasury from issuing any net new debt. There are a variety of legislative paths forward for solving this issue, however the potential consequences of failing to act timely are extremely severe. The worst outcome would be a default on U.S. government debt which would likely have catastrophic economic and market effects. There’s never a dull moment in Washington D.C. and the upcoming months will be no different.
Making Sense of It All
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