by William Henderson, Vice President / Head of Investments
Last week seemed to be a tale of two markets. After starting the week off lower Monday and Tuesday, the markets came roaring back in a big way by week’s end after earnings announcements surprised to the upside and weekly unemployment claims declined much further than expected. Last week, the Dow Jones Industrial Average rose 1.6%, the S&P 500 Index increased by 1.8%, and the NASDAQ moved higher by 2.2%. Investors took advantage of the market’s 5% pullback in September and continued to pour money into equities. Last week’s rally added to an already strong year. Year-to-date, the Dow Jones Industrial Average has returned +17.0, the S&P 500 Index +20.4% and the NASDAQ +16.2%. Bond yields continued to rise as expectations of tapering of bond purchases by the Fed and higher short-term rates next year crept into fixed income traders’ plans. The 10-year U.S Treasury closed the week at 1.61%, 86 basis points higher than one year ago but still modestly below the March 2021 high of 1.74%.   

As mentioned, the economy and resultant earnings announcements continue to surprise to the upside suggesting there is still plenty of steam left in the economic recovery. A clear indication of the strength of the economy was last week’s decline in unemployment claims. See the chart below from the Federal Reserve Bank of St. Louis showing the continued precipitous drop in unemployment claims over the past year and reaching the lowest level since March 2020. 

One piece of information released last week was certainly good news for retired folks and Social Security Income recipients. According to the Social Security Administration, payments of America’s 64 million retirees will increase by 5.9% next year in the retirement benefit’s biggest cost of living adjustment (COLA) since 1982. While this “wage inflation” adjustment seems like good news to retirees, the reality is that the cost goods and services in the U.S. is increasing at recently unprecedented levels. Last week’s release of September CPI (consumer price index) showed inflation is continuing to heat up. CPI was up 5.4% year-over-year due mostly to food and energy prices, while Core CPI (ex food and energy) was up 4% year-over-year. (See chart below from Bloomberg). 

Clearly, the Fed has successfully engineered inflation (as was their plan all along). And having annual inflation well below their 2% target level, we are going to get numbers well above 2% to move the average number higher. The question for the markets and investors is: Will inflation be transitory or permanent? Generally, energy prices can be transitory as supplies eventually catch up to demand and prices adjust. However, wages and food price increases tend to stick around much longer. Large and powerful unions such as the Longshoremen and Teamsters will use the current supply chain disruptions and cargo ship back log to negotiate labor contracts more favorably for workers. Conversely, continued improvements in technology such as microchip capacity and cloud storage prices will put negative pressure on inflation and resultant prices. 

The concerns with China seem to have softly abated this week as the Chinese Central Bank (PBoC) reported that the problems with Chinese real estate developer Evergrande, are unique to the company and not endemic of the overall real estate market in the country. Additional positive news for the U.S. came around shipping rates from China. China’s official Global Times reported last week that shipping rates from China to the U.S. west coasts are down 22% over the past 4 weeks. While west coast ports are still congested, the tide may have turned on the supply of available goods which will clearly help to ease inflationary pressures.    As mentioned above, earnings announcements from companies last week surprised to the upside; specifically bank and financial stocks topped analysts’ expectations with names like Goldman Sachs showing higher revenues from trading and investment banking. The threefold pressures on economic growth: positive earnings releases, unemployment claims dropping, and softening of global supply chain disruptions all point to the potential of solid market returns for 2021. Inflation will remain a concern and COVID-19 variant cases, while lessening globally, could impact the economy going forward if we see a spike later in the year. As always, keep to your long-term financial plan and understand the markets are more efficient than investors. 

by William Henderson, Vice President / Head of Investments
The past week in this newsletter, we talked about long-term trends in the stock market and how that view will pay off much better than trying to time the market by picking highs and lows, and moving money based on those wishful targets. As you know, we are not market timers, we talk about consistent investment plans and consistent investing. These mantras have paid off well and have been, in our opinion, the correct way to invest. The financial news media, which has gained in popularity over the past 20 years needs headlines to attract readers and viewers. “If it bleeds it leads” was the old media trope; with the thinking being grab the viewer’s attention and keep them glued to the channel. Financial media follows this pattern – generally. There’s always the invisible wall of seemingly insurmountable obstacles to the markets doing “better.” We see this today everywhere in the financial headlines – inflation, supply chain disruptions, China, bond tapering, and quadrennial classic – “The Debt Ceiling Debacle.”   

Certainly, the issues above are real and deserve attention and to be addressed. Already, Congress passed a magic stop gap bill printing additional billions of dollars to keep the government running. Does anyone remember what happened the last three times the government shut down (one time each during Clinton, Obama, and Trump’s term)? Nothing! Americans went on doing their thing and getting the job done. 

Inflation? Jerome Powell succinctly told everyone he wanted inflation to average 2%. There has been a lot of concerned chatter about inflation lately with everything from food, to energy to commodities costing more; but we have been below 2% for far too many years. (See the chart below from the BLS and JP Morgan, showing CPI and Core CPI since 1971.) Only very recently have we started move above the 2% target, thereby moving the average closer to 2%. The Fed is getting what it designed – inflation will be here until it averages 2% at which point the Fed has said it will raise rates.  

The supply chain disruptions are real, and it is going to take a long time to unravel. There are something like 110 cargo ships anchored or drifting off the coast of California. Each of those ships carries about 1,000 containers. That is 110,000 truckloads of goods that need to be offloaded, loaded onto ground transportation, and moved across America. During the mandated COVID-19 lockdown, truck driver training schools shut down, which has led to a dreadful shortage of trained truckers. If you are waiting for your new dishwasher or shipment of semiconductor chips; they are likely floating off the coast of California.   

China is going to continue to be in the headlines – as you would expect for the world’s second largest economy. China is a country struggling to be a serious world power – a communist capitalist country – yet one where their President Xi Jinping is working to get reelected to a record fourth term next year. China’s actions and reactions certainly impact the global economy. 

Each of the above issues are surmountable; and the market has proven time and time again that it will move past headline grabbing events. In the short run they are common and normal pullbacks. It took nearly a full year, but the S&P 500 finally had its first 5% pullback of 2021 last week, thus ending hopes of 2021 joining 1954, 1958, 1964, 1993, 1995, and 2017 as the only to go a full calendar year without a 5% move lower. (See the chart below from Clearnomics and Valley National).   

The markets and the economy are facing short-term obstacles that deserve attention. The Fed is giving us sustained monetary policy and Congress continues to dribble fiscal stimulus, albeit with a high degree of infighting and backroom brawling. The COVID-19 variants are waning, while vaccine distribution continues to expand globally. Supply chain disruptions are impacting inflation and energy prices are spiking right in front of winter. Thankfully, the consumer has a healthy balance sheet alongside banks and Fortune 500 Corporations. The market is adjusting itself and reacting accordingly and efficiently. 

NOTE: The Numbers & “Heat Map” will return to The Weekly Commentary next week, October 19, 2021.

by William Henderson, Vice President / Head of Investments
Markets were weaker across the board last week as each major index show a negative return. Further, as noted earlier last month, September proved to be a losing month overall, keeping with stock market history. Last week, the Dow Jones Industrial Average lost -1.4%, the S&P 500 Index lost -2.2% and the NASDAQ closed -3.2% lower. Poor weekly showing by the indexes chipped away at year-to-date gains, but each major index remains solidly in the black column. Year-to-date, the Dow Jones Industrial Average has returned +13.7%, the S&P 500 Index +17.3% and the NASDAQ +13.6%. Bond yields rose last week as implications of reduced monetary stimulus, inflation concerns and the Fed’s previous announcement of bond purchase tapering by year 2021, sank in and investors reacted accordingly. The 10-year U.S Treasury closed the week at 1.49%, eight basis points higher than the previous week but still below the March 2021 high of 1.74%.   

Much has been made of the Fed’s tapering and parallels have been drawn between the 2013-2014 “Taper Tantrum,” where the Fed previously announced and subsequently followed through with a substantial tapering of bond purchases. The chart below from Bloomberg shows the 10-year U.S. Treasury during two periods of rising rates (2013-2014) and (YTD 2021). In both instances, rates rose, and volatility entered the bond markets. However, also during both periods, the stock market continued its broader bull runs.  

In our opinion, bond yields are impacted by the Fed while they maneuver through economic recessions and expansions, while the stock market is impacted by demographic trends and global macroeconomic factors such as GDP growth and population growth. This is evidenced by the chart below from YCharts and VNFA, where we show U.S. GDP and the S&P 500 Index from 1950 to present with recessions shaded. Notice the trend, from bottom left to upper right; and during all this time we had periods of bond yields falling and rising as impacted by the Federal Reserve’s monetary policy. Certainly, volatility in markets will never go away but trends are here to stay.   

Looking beyond the U.S. economy and markets, we see some economic headwinds in a few places. China, the second largest economy behind the U.S., is dealing with supply chain concerns, energy shortages and fall out from Evergrande, the world’s largest indebted real estate developer, where bond holders are still awaiting their interest payment. Inflationary concerns are shared in many parts of the world as energy prices, food prices and labor shortages compound each other putting serious headwinds in the way of a global recovery from pandemic. In the U.S., lawmakers are still debating spending bills and an increase in the federal debt limit; both of which add unneeded uncertainty to the markets. While no one expects the U.S. Government to default on its debt, the anxiety produced by pandering on both sides of the aisle in Congress does not help the markets. Both sides know the debt limit must be increased but neither wants to be held responsible for adding more to the mountain of federal debt which already exceeds $28 trillion (about $86,000 per person in the U.S.).   

It is likely that the debt limit will be increased in the eleventh hour simply because the result of not doing so would be catastrophic and neither side of Congress wants that to happen. Given how relatively low interest rates are, the cost of borrowing by the government to finance its activities also remains historically low; thereby naturally permitting greater amounts of debt. See the chart below from Bloomberg showing U.S. Government Debt limit levels and the S&P 500 Index. The market has consistently proved itself to be more efficient and forward thinking than our own congressional leaders.   

We expect the Fed to keep interest rates low even as they engage in bond purchase tapering. The economy will continue to improve while dealing with COVID-19 variants, supply chain issues, higher energy and raw material prices, and squabbling in Washington but volatility in the markets is the result. Keep focused on long-term trends and returns rather than the short-term volatility.