Market & Economic Update – October 2021
October 8, 2021
By, Peter Mueller & Steve Taddie
Asset price momentum and positive economic narratives continued in financial markets throughout July and August only to retreat in September leaving price levels near where they started in July. Seasonally, markets tend to be choppy and weak in September and October and this year has been right on cue. Seasonality coupled with the absence of a 5% or greater price pullback along with the political noise and uncertainty out of Washington provided the set-up for some quarter end market malaise. While declining markets are never fun, they are quite normal. In fact, 10% price corrections tend to occur at least once during every 18-month period and are common within the context of a market that has seen strong gains – such as this one. These price drawdowns can remove some of the exuberance in markets and begin to build a base for the next advance – all healthy characteristics for the long-term investor.
Despite the September weakness in stock prices and concerning issues du jour (i.e., delta covid variant, political discord, supply chain and labor constraints, China, and expectations for monetary and fiscal policy adjustments) the economy continues to grow by 5.6% in 2021 – albeit at a slower pace than previously forecasted due to the drag created by the delta surge and supply and labor constraints (NABE). While we are nowhere near a recession, the outsized percentage gains in US gross domestic product (GDP) and inflation from pandemic lows are in the side-view mirror, and soon to be in the rear-view mirror. We are entering a glide-path from an accelerated rebound driven by economic activity, to more sustainable growth levels where year-over-year gains in the future will be hard earned. Rising costs have put upward pressure on producer prices, which need to be passed on to retain profit margins. Successful companies will be able to manage inflationary pressures and exert pricing power in the marketplace to adequately pass on these rising costs to end consumers. This creates much of the inflationary themes we are monitoring and experiencing today. They key question becomes whether these inflation pressures are temporary (meaning the outsized increases today revert to a normal 2% annualized increase) or, if in fact they become permanent – slowing consumption and eroding the purchasing power of savings. As of now, this appears to be temporary due to supply and labor distortions resulting from the pandemic led economic shutdown which should abate with time – stay tuned.
We remain optimistic on stock price valuation and future market direction despite the likelihood of increased volatility as we navigate 3rd quarter earnings season and a November Federal Reserve meeting in which the details of the tapering of its asset purchase program (quantitative easing) should be announced. Current 2022 earnings for the S&P 500 are estimated at $210 per share with the likelihood that earnings should accelerate further as we get past the headwinds of covid, supply constraints and labor constraints. Based on these estimates, the market currently trades at 20 to 21 times earnings which is reasonable given the low interest rate environment, increased productivity, and accelerating earnings.
Fiscal (legislative spending) and monetary (interest rate and asset purchase) policy remain the main driver of both current economic conditions and expected economic activity and asset returns. Current fiscal policy is focused on the hopes of a large government infrastructure spending program to boost economic activity, create jobs, and build for our future. There is some opaqueness in the details (Washington politics…) making it hard to put a firm number on the amount to be spent, so for simplicity, we will assume targeted amount is north of $3 trillion, which by comparison is larger than the cross-border economies of Mexico and Canada combined. Tax increases imposed to pay for the spending do minimize the economic boost typically enjoyed by fiscal spending – this is all in the works so we will have to wait to see the final details to adequately assess its economic and market effects.
The Federal Reserve is expected to begin “normalizing” its current monetary policy which is supportive of economic growth to a more neutral policy down the road as the economy and labor markets regain their footing. While this generous pandemic support will be ending, the tapering, or reduction of the support, is expected to be gradual and deliberate – thus weaning our economy off the monetary stimulus. Market participants have been anticipating asset purchase tapering well in advance, so we are hopeful that its market effects will be muted. Current estimates are for the Fed to taper its asset purchases over a 6 to 9 month period and interest rates to begin moving off the 0% pandemic low beginning later next year, or possibly 2023. Achieving policy balance, effective communication to the markets, and consistency and gradualism should help soothe markets. The concern is that the Fed’s gradual path becomes too slow as inflation pressures build – thus forcing the Fed’s hand to tighten monetary policy sooner rather than later – all a delicate balance!
Despite all the noise and issues of concern in the system today, we remain optimistic for economic growth, labor, and market returns. While there are many moving parts in today’s economy and markets as we weave through covid, politics, fiscal policy, monetary policy, and corporate earnings we are confident in the individual investments in your portfolio. Our aim is to develop a sound economic outlook pared with prudent security analysis with the goal of stacking the investing odds in your favor. We strive to look past short-term noise to a longer-term rationale for owning an investment which helps us build an economic moat around the core of your portfolio. We will continue to invest in stable and growing businesses that we believe to be characterized by strong balance sheets, good earnings and cash flow growth, and in defensible businesses. We pair this investment selection with the goal of acting with a long-term (3+ years) investment time horizon.
All the Best,
Steve Taddie Peter Mueller
The discussions and opinions in this commentary are for general information only and are not intended to provide investment advice. While taken from sources deemed to be accurate, HoyleCohen makes no representations about the accuracy of the information in the commentary or its appropriateness for any given situation.
Photo by Johannes Plenio on Unsplash
