Quarterly Market Commentary: September 30, 2021
INTEREST RATES MOVE HIGHER
U.S. stocks were tracking to another strong quarter through July, August, and most of September. At one point, U.S. stocks were up over 20% for the year. A late September swoon caused stocks to decline 4.6% in the month, resulting in a small negative return of -0.10% for the quarter. Foreign stocks experienced a similar fate with a late September sell off pressuring quarterly returns. Concerns over China’s clampdown on high growth industries also weighed on foreign stock sentiment. Foreign stocks declined 2.99% in the quarter. Despite a flat quarter for U.S. stocks, year to date returns of 14.98% and 31.86% over the past year are strong. U.S. bonds returned 0.02% for the quarter, outpacing stocks. Year to date returns for bonds are negative 0.87%, reflecting the increase in interest rates. In the short term, higher interest rates mean lower bond prices, thus pressuring returns.
What caused the September stock sell off? A variety of contributing factors can be considered, but the most likely culprit was interest rate increases. The yield on the ten year U.S. treasury bond spiked from 1.30% to 1.49% in less than two weeks. While the overall interest rate level remains low, still some of lowest ever, a sharp 15% increase in bond yields took markets by surprise. The yield increase coupled with Federal Reserve Chairman Powell commenting that inflation pressures may not all be transitory set the stage for a reassessment of the future path of interest rates. Interest rates should and need to increase for the economy to stand on its own. Current rates are suppressed by significant Federal Reserve bond purchases and ultra-accommodative short-term interest rates. The question markets are wrestling with is how fast the Federal Reserve curtails these activities.
Global pandemic related lockdowns severely curtailed economic growth in 2020 especially from March to June. Amazingly, economies have largely returned to normality via record setting growth rates. The U.S. economy grew 12.2% in the most recent quarter. As growth rate comparisons get harder, economic growth should decelerate. Third quarter, fourth quarter and 2021 U.S. economic growth estimates are 5.6%, 5.8% and 4.1%, respectively. Company earnings growth rates are exhibiting a similar pattern with growth likely peaking in the June quarter. 2021 annual earnings are expected to grow an astonishing 46.3% after a 13.9% decline in 2020. For 2022, expected earnings growth is 9.2%. Interestingly, estimated earnings growth rates have increased since the beginning of the year helping boost stock prices. Estimating future earnings continues to prove challenging in both good and bad times.
Peak growth should not set off alarm bells. The U.S. economy is scheduled to grow 4.1% in 2022. This is the second highest economic growth rate in the last twenty years, a robust backdrop for strong earnings. Strong secular trends include digital adoption, restoring supply chains, healthcare innovation, renewable energy and e-commerce. These trends, coupled with strong consumer balance sheets from record home prices, low interest rates and excess savings, provide support for better than average economic growth.
THERE IS NO ALTERNATIVE (TINA)
A growing chorus of investors and commentators are referring to U.S. stocks as TINA. “There is no alternative.” After ten years of strong stock results, 16.6% annualized returns, it is difficult to argue that U.S. stocks have not generated better than expected returns. Stocks have also significantly outperformed bonds. Stocks are riskier than bonds and should have higher expected returns. Actual returns have confirmed this expectation. Again, this is not a surprise nor unexpected result.
However, we would caution against blindly assuming U.S. stocks are the only asset class worth considering for all investors. First, many investors do not have the ability nor willingness to accept the associated risk. Over the past decade, an all-stock portfolio would have experienced several declines of 20% or more including a decline of nearly 40% last March. Second, asset classes often exhibit lengthy periods of over and under performance. Emerging market stocks were once the talk of the town. Last, past performance is not indicative of future results. Momentum often swings when you least expect it. While we certainly view U.S. stocks as a core allocation, often the largest asset class in more growth oriented portfolios, we would prefer to say there are many alternatives for clients to consider in order to have a portfolio that meets their return goals and risk preferences. That is why we work closely to understand our client’s financial goals and needs and believe strongly that every portfolio should reflect a client’s personal circumstances. One size does not fit all.
The information contained in this material is based on sources believed to be true and reliable; however, its accuracy is not guaranteed. This material should not be construed as a recommendation to buy or sell specific securities. Views are based on market conditions, economic data, and other information at the time of publication and are subject to change.