Marketing Outlook: End of 2021
If the year ended today, it would qualify as a better than average year for the financial mar-kets. Despite a rocky September, through the first three quarters, the S&P 500 was up about 15%; this despite a 5% decline in September. While we’ve seen volatility in September, if the market can hold this watermark, returns would be above the historical average of 11-12%, and it would qualify as a good year. So, what about the rest of the year?
We are currently in a seasonal weak period for the financial markets. Since 1926, September ranks as the weakest month of the year. The decline this year was larger than the historic average decline of about 1%. Taken together, September and October are historically the weakest 2-month period of the yar. However, the fourth quarter is historically the strongest quarter of the year. Importantly, our July portfolio rebalance was designed to better weather interest rate volatility and tempered cyclical exposure slightly.
In my view, there are three key issues as we head toward the end of the year: 1) The economic restart, 2) Fed Policy and interest rates, and 3) inflation.
Even though the Delta Variant has caused concern, the economic restart, while not bullet proof, appears real and is being driven by availability and efficacy of vaccines, economic stimulus, pent up demand for goods and services, and high consumer savings.
According to the CDC, as of late September about 77% of US Adults have had at least one vaccination. And the US consumer has been flush with savings. In March, the US savings rate was 27%, or about three times higher than normal; so there has been substantial wherewithal to spend. Also, the economic stimulus provided in reaction to the pandemic was huge - close to 25% of GDP. As a reflection of a strengthening economy, corporate earnings expectations have been on the rise. GDP growth is expected to be 6 - 6.5% this year.
That brings us to the Fed, which has kept rates low and has been willing to have the economy overshoot its inflation target of 2% until there is significant progress on in the labor market. The Fed is likely to let the econ-omy run a bit hotter than normal for some time. This should help growth, but yields on bonds are low, creating challenges for fixed-income investors.
That brings us to inflation, our third key issue. The inflation rate as measured by CPI was 5.3% in August and 5.4% in July; well above the historical rate of 2.9% since 1926. And the gap between interest rates and inflation is the largest it’s been since 1980. So, with 10-year government bonds recently yielding 1.4%, corporate bonds at around 2.4%, and inflation at 5.3%, purchasing power is contracting by 3-4%. All of this means that an inves-tor heavily invested in bonds could be losing ground to inflation producing a negative real return.
Generally, equities tend to do better in inflationary times and historically have served as a hedge. But not all equities are created equal, and according to a recent analysis by Blackrock, investors are arguably under-weight inflation fighters in their portfolios.
Investors tend to de-risk their portfolios with fixed-income the closer they get to retirement. So, for retirees, it’s more important than ever to have a financial strategy in place to make sure they are not losing out to inflation.
- Commentary by Jerry Herman, CFA®
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