October 20, 2021
After many months of back-to-back gains, global stock markets faltered in September and ended the third quarter on a slightly down note, marking a pause in the remarkable rally since the COVID lows 18 months ago.
The lull may be ascribed generally to the pandemic. Renewed lockdowns caused by the Delta variant this summer forced factories in many countries to keep workers home and cut back production, even as demand for goods swelled. Meanwhile, shortages of raw materials and labor tangled supply chains, throwing global trade into disarray and exposing the vulnerability of just-in- time inventory management.
US unemployment has fallen from a high of 15% in April of 2020 to just 5%, well below the 50-year average, and employers are now struggling to fill job openings. In the UK, COVID contributed to a worker exodus, just as Brexit curtailed immigration and raised trade barriers, leaving the country sorely understaffed with gas stations shut and supermarket shelves bare.
In the midst of a rapidly reopening economy, these supply chain disruptions and labor shortages have combined with rising energy prices and wage gains to cause a spike in inflation. The consumer price index for August clocked in at over 5% year over year, the highest level in thirty years, raising fears that the Fed may tighten monetary policy sooner than expected, throttling the US recovery.
Meanwhile, Chinese government actions to tighten control over social media, technology, private education, and the red-hot local property market, have cast a short-term pall on growth prospects in the world’s second-largest economy. In a sign of ongoing geopolitical friction, President Biden has not removed Trump-era tariffs on Chinese goods, and the Chinese military has been making provocative incursions in the Taiwan Strait.
Despite the recent pullback and this litany of concerns, three consecutive years of strong gains have left stock and bond prices near record highs. Over that time, global stocks have returned an average +12.5% per year and bonds have gained over +5% annually. US home prices are in an upswing not seen since before the 2008 mortgage crisis. Investors who have weathered through the markets’ storms have been well rewarded.
Our client portfolios benefitted from the strong equity markets earlier in the year, while managing to sidestep the more negative climate for bonds. Our equities have kept pace with global stocks, with the MSCI All Country World Index up 11.12% through September 30. Our defensive position in bonds reflects our concern that inflation and interest rates were likely to trend higher and this has helped so far in 2021. While the broad bond market is down -1.55% for the year, our fixed income holdings have held their ground, as have our alternative strategy funds.
Perhaps surprisingly, given the pandemic’s challenges, disparities and tragedies, American consumers have enjoyed a surge in wealth of significant proportions. The net wealth of all households is $32 trillion higher than just two years ago—a 28% increase fueled by government largesse, and rising markets and home values. Low interest rates have reduced the burden of household debt service as a percentage of income to the lowest level in forty years. At the same time, after decades of stagnation, workers are benefiting from the strongest wage growth since the 1980s.
Roughly 80-90% of Americans have some level of immunity either due to vaccinations or having contracted COVID. Confirmed cases are down 30% from the summer peak and, though winter weather and indoor activity present a risk, the pool of vulnerable people shrinks daily. People and the economy are adapting and the US gross domestic product has surpassed its pre-COVID high.
Despite recent supply disruptions, the global economy continues to build momentum. Manufacturers and raw material providers will ramp up production as fast as possible to benefit from strong demand. Price inflation should abate as supply chain challenges are steadily resolved. Growth in the final months of the year and into early 2022 is likely to accelerate after the weak third quarter. Furthermore, corporate profits have surged by over 60% this year compared to the depressed levels of 2020 and are expected to grow by a healthy 10% in 2022.
Taken together, these factors point to a positive economic climate in the coming year.
Challenges will, of course, remain. COVID could create another round of turmoil. Higher input prices, labor costs, and interest rates will put pressure on corporate profit margins. Inflation could prove surprisingly intractable if consumer inflation expectations fuel a wage and price spiral. A “policy mistake”—premature tightening by central banks—could trigger a recession. Government stimulus will fade, while taxes seem likely to rise. Looking further ahead, the global economy will inevitably slow once the recovery has played itself out.
Investors would be wise to prepare for less-generous returns in the next few years, and to review their asset allocation to ensure they are not overexposed to equities. Excessive pessimism, however, seems unwarranted by current conditions.
We wish you a wonderful autumn and look forward to a happy and healthy holiday season.
David, Harlan, Doug & Maria
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