The final month of the third quarter erased a good portion of QTD gains, in some cases, resulting in net losses. Volatility increased dramatically after several months of lackluster activity. This year, September lived up to its historical reputation as the worst month for equities.
Domestic benchmarks probed the upside repeatedly earlier in the quarter with modest new highs scored by a handful of indexes in late August. But by mid‐September, stubborn inflation, clear signals from the Federal Reserve that its bond market support program is nearing an end, and intense partisan wrangling on Capitol Hill, proved too much for even optimistic investors. Equity and bond prices ended the quarter widely mixed.
International Developed and Emerging Markets followed the US lead, losing moderate gains as our equity performance turned choppy with Emerging Markets the quarter’s biggest losers. Representative global equity benchmark index performance for the periods indicated is illustrated below.
Several factors are weighing on markets. First, the intractability of inflation is proving far more pervasive than we (and the Fed) anticipated when reopening pressures earlier this year created a strong demand resurgence. Supply chains remain choked and consumers, perhaps most notably in supermarkets, are experiencing elevated costs and spot shortages.
Prices that rose early in the second quarter have not retreated and anecdotal evidence suggests that demand continues to outstrip supply in many economic sectors. Reports from major US ports detail significant numbers of arriving ships but limited shore‐based unloading capacity.
In late September, more than 130 cargo and container ships were anchored off the Ports of Long Beach and Los Angeles. Approximately 60 were being unloaded, which seems reassuring, but Port officials note the number of ships unable to be immediately offloaded post‐arrival is normally” zero or one.”1
The multi-decade conversion to “just in time” inventories for manufacturing companies has proven severely limiting in the face of surging demand. Estimates to return to normal operations range from 3-12 months, which implies that current shortages and demand-push inflation will continue.
A second concern for investors is future leadership of the Federal Reserve. Mr. Chairman Powell’s term expires soon and to date, the Biden Administration has not expressed any likelihood of renomination.
Progressive Democrats, however, have been vocal and adamant that Powell should not continue to lead monetary policy. Cautionary notes from the Chairman earlier this year counseling against unlimited spending in the name of Covid relief and his strong assertion that central bank policy would not be configured to combat climate change have landed Mr. Powell on the Democrats’ unfavorable list.
We suspect a replacement will be one more sympathetic to the Progressive agenda, should he/she be confirmed by Congress. Democrats’ clear preference is for a chairman undisturbed by deficit spending, inflation, and explosive money supply growth.2 Markets may have a contrary view.
Paul Volker was the last Fed Chairman faced with accelerating systemic inflation and those old enough to remember the early 1980s will not wish for a similar ride. Without a return to normally functioning supply chains, more energy independence, and political leadership that believes supply, not just demand, must be stimulated, inflation will become embedded in the economy. It would be an inexorable, insidious, regressive tax on American consumers with draconian interest rate hikes the only known remedy.
In addition to net weak equity and bond performance in the third quarter, the administration’s bellicose insistence on universal Covid vaccines is causing significant dislocations in the workforce where companies are requiring vaccination as a condition of continued employment.
Hundreds of thousands are finding themselves unemployed for refusing “the jab,” despite their claims of natural immunity from past infection (or simply personal decisions to decline vaccination). Federal and many state governments’ refusal to recognize post-infection immunity as equally effective to vaccine protection is puzzling. A comprehensive Israeli study published in August details that recovery immunity is stronger and longer lasting than from any currently available Covid vaccine.3
So, why is this dilemma for workers and employers significant?
Aside from questions of community responsibility and personal liberty, a shortage of healthcare workers, for example, could have severe consequences. The latest Jobs Openings and Labor Turnover Study (JOLTS) from July shows nearly 11 million unfilled employment opportunities.4
The survey also reported 274,000 new openings in healthcare, which will only multiply as vaccine mandates take effect this month and next. Other high contact professions will be similarly impacted.5 The next update of this survey will be in mid-October and can reasonably be expected to show a new net increase in job openings.
A supply squeeze coupled with a labor shortage is a recipe for further inflation. Wages must rise to attract replacement workers, commodity prices, driven by energy, continue firm, and the President’s approval rating on myriad subjects is plunging, eroding investor optimism in the country’s direction.6
Predictably, consumer sentiment is matching the President’s sliding approval rate. Confidence in the economic outlook remains relatively strong by historical standards but the widely followed Conference Board’s Confidence Index declined all three months last quarter from its June peak at 128.9 to 109.3 by September.7
So why aren’t equities weaker as future confidence declines?
Earnings. Third quarter reports arrive imminently and are expected to again provide pleasant reading for investors. Additionally, the economy remains awash in monies previously appropriated but not yet spent. A vast pool of liquidity is sparking not only strong demand for consumer goods but also apparently supporting market rebounds after sudden selling squalls.
Many individual issues have lost far more than popular averages, suggesting we are in a rolling correction, discounting slower earnings growth rates ahead. This process will continue until exhausted and expected rates of return for individual companies attract more aggressive buyers.
Underlying economic momentum portrayed in statistical reports is providing the rationale for new investment, keeping equities within striking distance of highs. Consumer confidence is notoriously volatile and could easily reverse to the upside should inflation, the prospect of higher taxes, and/or unemployment diminish.
The President’s agenda is currently stalled in Congress, a victim of Democrat infighting and declining Presidential job approval. Despite the tendency of equities to snapback repeatedly from declines, the path of prices over the past 6-8 weeks has been on balance lower. We have discussed the likelihood of downward earnings multiple revisions resulting from the anticipation of increasing taxes and regulations, which is quite possibly what is occurring in the markets at present.
1“Fact check: Dozens of ships waiting off California coast amid backup at ports,” www.usatoday.com, September 28, 2021. 2 “Elizabeth Warren calls Fed Chair Powell a 'dangerous man' and vows to oppose his renomination,” www.msn.com, September 28, 2021. 3 “Jaw-Dropping Academic Study Shows Natural Immunity Superior to COVID Vaccine,” www.swfinstitute.org, August 26, 2021. 4 “JOB OPENINGS AND LABOR TURNOVER – JULY 2021,” www.bls.gov, September 8, 2021. 5 Ibid. 6 “Joe Biden's Approval Rating Hits All Time Low in New Poll,” www.newsweek.com, October 7, 2021. 7 “Consumer Confidence Survey®,” www.conference-board.org, September 28, 2021.
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