This blog will serve as follow up to our previously released Q3 Investment Themes and is intended to provide an update on what we are seeing as well as our current outlook.
Here are the top three things we are covering in this week’s blog:
- The market began Q3 strong but faltered during the month of September over a renewed fear of COVID lockdowns and rising inflation.
- Despite most economic data measures slowing in Q3 after monumental expansion in the previous quarter, growth remains elevated above pre-pandemic levels.
- We will preview the rumored tax bill and provide commentary on what this could mean for mid – high net worth individuals.
The Market
After countless months of strong returns, the market gave back some of the previous gains during Q3. In line with our expectations for slowing, September was the worst month for the market since March of 2020. Despite being up over 5% in late August, the S&P fell hard in September to a near flat QTD close of +0.23%. After underperforming for much of the first two quarters, the Nasdaq led all the other major indexes and finished +0.93%. With growth slowing, the Dow Jones underperformed with a close -1.91%. Following an outperformance in Q1, the Russell 2000 continued to struggle and finished a mediocre -4.60%[1].
Following a surge to begin 2021, the 10-year Treasury-Yield retracted for much of the summer. But as the market began to adjust to more of a Quad 2 (inflation accelerating) environment, yields began spiking once again. From the beginning of August to end of September the 10-year yield rose more than 30 basis points, a very large move relative to the current value[2].
On the back of momentum from a tremendous 2nd quarter and inflation readings above expectations, commodities rallied further in Q3 posting a +6.58% gain[3].
European Equities grinded higher for most of the summer before following U.S. indexes to a negative close -1.94%[4].
Emerging markets remain bearish after correcting during the early summer. Despite a week bounce off the lows, emerging markets closed -8.84%[5].
A mixture of improving economic data and concerns over sooner than expected Fed tapering led to big losses in precious metals. Gold showed relative outperformance and managed a close -1.04%. Silver looked strong to begin the quarter before falling to -4.47% on the back of spiking yields. After large gains to begin the year, Copper fell into correction territory during Q3 and finished -16.01%[6].
The Economy
Quad 3 in Q3 came to fruition with growth slowing while inflation accelerated. Even as some COVID driven supply and demand inflation slowed in Q3, median and underlying price CPI further accelerated. Likewise, we witnessed the Fed’s call for transitory inflation begin to fade as their CPI nowcast continued to shoot higher. These forecasts estimate inflation will remain elevated well above pre-pandemic highs in the near term. However, unlike in Q2 when nearly every industry in the market experienced historic growth, a mixture of increasing COVID concerns and decreasing consumer confidence led to slowing in service activity. This sticky stagflation (slowing growth, rising inflation) gave way for a stagnant quarter in the markets[7].
The unemployment rate continues to trickle down from the March 2020 spike and fell to a new pandemic low of 5.20%. Coming off the lows from 2020, YoY GDP spiked to 12.20%. While both readings have provided some support to the market, we expect slowing to occur as soft COVID comps move to the rear-view[8].
After the strongest quarter for most economic data measures in recent history during Q2, the third quarter showed some signs of slowing growth. However, most readings remain elevated well above pre-pandemic levels. Additionally, many market participants began fearing another wave of COVID shutdowns as Delta cases began spiking in early Summer. But in recent weeks the cases have begun peaking and we expect to see the drop off deepen before any major shutdowns occur. This should help to ease concerns and bring back investor confidence. While we do expect to see GDP slow in coming quarters, the reading will likely maintain well above pre-pandemic levels. One indicator of future strength in GDP is the spike in ISM Backlogs alongside a collapse in Inventories. As inventory begins to catch up to demand, we will likely see a bump in GDP. With the latest wave of COVID cases beginning to peak; new hiring, wages, and consumption are all set to rise giving way to renewed growth. As a result, we expect to see a shift back to Quad 2 during the fourth quarter[9].
After showing atmospheric growth of 12.18% in Q2, GDP is expected to taper in Q3. However, our third-party research still estimates GDP to maintain at high levels throughout the end of 2021 and into 2022. YoY CPI in Q2 fell in line with the high expectations at 4.85%. Unlike many of the other economic data figures, Hedgeye estimates CPI to inflate further in Q3 to 5.25% before coming down slightly in future quarters[10]. While the economic data still supports Quad 3 at this time, we do expect to see a shift back to Quad 2 in the coming quarters. During Quad 2 the economy experiences growth accelerating and inflation increasing. As we discussed previously, growth in many industries is very predictable with the massive drop in inventories. Furthermore, as COVID restrictions wind down the economy will receive supplemental support from consumers waiting to spend. Additionally, the Federal Reserve has shown no concrete proof that they are planning to slow the use of the printing press to further increase global money supply. In a market that is largely swayed by Fed commentary, the money printing support has helped to protect from any long duration period of weakness[11].
Based on our analysis of the US and much of the globe being headed to Quad 2 (higher growth and inflation), there are investment themes that we have added to the portfolio that do well in a Quad 2 regime. Those are:
- Inflation Focused Equities & Commodities
- Real Estate & Tech
- European Equities and Commodity Focused Emerging Markets
Tax Changes on the Horizon
There are numerous important tax changes on the horizon, please see our previous blog to learn more and see how you may be impacted. Find the blog here.
In Summary
- The market hit a speed bump in September, but our research still expects to see supportive growth in the coming quarters.
- While most economic data indicators pointed down in Q3, we estimate a stabilization of expansion well above pre-pandemic levels.
- With a new tax proposal in the cards, it’s important to review your own current financial situation to determine if any advanced planning would be a benefit to you.
We hope you have enjoyed getting a deeper look into our investment research and look forward to providing this to you each quarter going forward. Thank you from the entire Konvergent Team!
[1] Slide 4: Major Indexes Hit Speedbump
[2] Slide 5: Bond Market Remains Volatile
[3] Slide 6: Commodities Glide Higher
[4] Slide 7: European Equities Underperform
[5] Slide 8: Emerging Markets Struggle
[6] Slide 9: Precious Metal Slide Worsens
[7] Slide 12: Growth Slows, Inflation Accelerates
[8] Slide 13: Unemployment and GDP
[9] Slide 14: Quad Shift on the Horizon
[10] Slide 15: GDP & Inflation
[11] Slide 16: Quad 2 Awaits