Wealth Matters Newsletter - October 2021

As we head into the fourth quarter, themes that we touched on in 2021 newsletters remain very much front-and-center in the minds of investors.  The rapid spread of the Delta variant, stubbornly high readings on inflation, and a U.S. Congressional impasse (as of this writing) on the infrastructure bill and budget pressured markets at the end of the third quarter. Sprinkle in a sharp rise in long-term interest rates and going-concern issues with Evergrande, one of China’s largest real estate development companies, and investors found plenty of fodder for a quarter-end pull-back.  

The rapid spread of the Delta variant appeared to have only minor impact on markets, overall, during the quarter, but leisure, hospitality, and travel industries certainly felt the impact.  Numerous companies in these industries warned investors about declining booking rates during the quarter and blamed the declines on Delta variant fears.  An uptick in vaccination rates during the quarter, and the potential for vaccination for younger children, has pushed COVID-19-related market stress to the back-burner, for now.  However, many companies are still grappling with the logistics and implementation of the Biden administration’s vaccination mandate.  Over the next few weeks, we anticipate hearing some commentary from corporate America during earnings release conference calls on how these mandates are being addressed.

Inflation edged down slightly in August, but is likely to remain elevated for longer.  The chart below shows the 20-year history of the Consumer Price Index, as tabulated by the U.S. Bureau of Labor Statistics.

Supply chain bottlenecks remain the primary cause of the spike in inflation; supply chains have been impacted primarily by labor shortages affecting nearly every segment of the supply chain from raw materials to transportation to finished goods. The Federal Reserve has been steadfast in its claim that current inflation levels are transitory or temporary, though recent testimony given by Federal Reserve Chair Powell to the Senate Banking Committee acknowledged that the current inflationary environment may be with us longer than the Fed had originally expected.  At its most recent meeting in September, the Federal Open Market Committee (FOMC), the Federal Reserve’s monetary policy setting committee, indicated that current bond buying operations (quantitative easing or QE) could begin to taper as soon as its next meeting in November.  In addition, forecasts from FOMC members indicated that interest rate hikes could begin as soon as next summer, rather than 2023 as was previously indicated.  The confluence of inflationary conditions, the projected tapering of QE, and a higher Fed Funds rate sooner than expected contributed to the move in long-term rates at quarter-end.  The chart below shows the yield-to-maturity history of the 10-Year U.S. Treasury Note since August 2, 2021.

With long-term rates having moved higher, albeit back to levels we saw in early summer, high stock valuations have been challenged.  Stock market indexes experienced some of the largest single-day declines in 2021 in recent weeks, and the month of September saw major indexes finishing in the negative (see the table below)..

We covered stock valuations and the associated impact from higher interest rates in our January and April newsletters; the impact on markets in September was as much a reflection on the direction of interest rates as it was the speed with which interest rates increased.  We anticipate high valuation stocks, particularly technology stocks, to be vulnerable to declines in the near-term due to interest rate environment.

Over the next few weeks, we expect heightened levels of volatility as investors attempt to assess elevated uncertainty.  Discord in Washington around the infrastructure and budget bills and the debt ceiling, stubbornly high inflation, and the growing concern that corporate earnings reports will be negatively impacted by higher input costs will likely keep investors wary.  We continue to view any near-term weakness as opportunity, but will be selective in our implementation.

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