Third Quarter 2021 Market and Economic Review

MARKET UPDATE

For most of the past year and a half, market returns have been in a near-constant growth mode following the steep decline caused by the Covid-19 pandemic (and a few other less publicized factors). The third quarter of 2021 saw that trend level off notably with the peak in the Dow Jones Industrial Average coming in mid-August.

Several factors are contributing to this leveling off in the markets, including the spike in covid cases caused by the Delta variant, the expiration of government support programs, analysts pulling back on Q4 projections, and some global upheaval - particularly in China.

Domestically, the quarter still finished higher than it started with growth isolated in the largest publicly traded companies. The S&P 500, which tracks the 500 largest U.S. public corporations, finished the quarter up 0.58% and up 15.92% year-to-date. However, much of that growth was driven by the largest 5 companies in the index, which make up 22% of the index value. For comparison, the next 5 largest companies comprise just 7% of the S&P 500 value. By the end of Q3, over half of S&P 500 companies were off of their highs by more than 10%.

Conversely, U.S. small-cap companies – measured by the Russell 2000 index – finished the quarter down 4.46%. As investors showed more caution in response to economic climates, this category, which tends to contain more aggressive stocks, is one of the first to drop as traditionally safer plays are sought.

International markets also finished the quarter slightly behind where it started. The MSCI EAFE, which reports on the markets of developed nations in Europe, Australasia, and the Far East, was down 0.45% for the quarter and up 8.35% year-to-date. Emerging markets indices showed some of the worst performance for the quarter with returns down 8.09%. Primarily this was caused by upheavals in China casting doubts in their markets. Most notably, China’s largest real-estate investor/developer, Evergrande, ran aground with many of its creditors. The company holds roughly $300 billion in bonds around the world and is causing concerns about China’s housing market.

Bonds were volatile during the quarter and continue to be negative for the year as rates are rising putting pressure on prices. The Bloomberg US Aggregate was down 0.05% for the quarter and remains negative for the year at -1.55%.

* Each benchmark is allocated based on the assumed Risk Profile of underlying indexes.

**Benchmarks include a mixture of ICE BofA US 3-month Treasury Bill Index, Bloomberg Global Aggregate X-US Index, Bloomberg US Aggregate Index, Bloomberg Multiverse Index., Bloomberg US Credit Index, MSCI EAFE Net Index, Value Line Composite Index (Geometric), and the Cboe S&P 500 BuyWrite Index. These benchmarks are the same as those in the Risk/Return and Account Analytics sections of client quarterly performance reports. By comparing your portfolio’s return to the benchmark with the closest risk/return characteristics, you get a more accurate reading of portfolio performance than using a less diversified benchmark, such as the S&P 500 index.

ECONOMIC UPDATE

Like it has been throughout the year, the U.S. Federal Reserve is taking a cautious, wait-and-see approach on inflation and interest rates. While pricing has been on the rise, much of it is still viewed as temporary in nature.

Coming out of its September meetings, the Federal Reserve’s approach, for now, is to continue to taper its purchases of bonds with an expectation of reaching zero around mid-2022. Presently, the Federal Reserve is purchasing about $80 billion of Treasury bonds and $40 billion in mortgage-backed securities per month. Additionally, interest rates are now forecasted to begin rising towards the end of 2022.

Initially, both pieces of information were positively received by the markets as the Federal Reserve is showing confidence that the recovery will continue. The markets then pivoted in a negative direction due to some of the worries below and the desire for further support.

The Biden Administration’s struggle to push through its preferred infrastructure bill is helping to hold the markets in a wait-and-see mode. In this case, Biden’s initially proposed $3.5 trillion infrastructure bill has been whittled down to $1.5 trillion. Political positioning from Democrats in the House currently means nothing at all has passed as of this writing.

A more important action for the federal government to take will be raising the debt ceiling. Political positioning and gaming on this subject have caused significant market corrections in the past. Even though the probability is very low, its mere existence is enough to keep some investments at bay until the decision is made.

Supply chain issues are also causing widespread problems in many different industries. For example, chip shortages in the automotive industry are expected to create shortfalls of around $210 billion for 2021 U.S. auto sales. Take into account other inflationary pressures and many companies are grappling with decisions to raise prices and protect earnings – specifically whether customers are willing and able to pay higher prices or not.

As always, we will continue to monitor portfolios, look for investments that meet our risk/reward targets for each of our clients, and make changes as necessary. Please reach out to us with any questions.