Macroeconomic View & Markets
The broad stock market, measured by the S&P 500, recorded a 5% drop from recent highs in early September. Selloffs are normal parts of market cycles and it has been almost a full year since one reached 5%. Such a long stretch has only occurred eight times in the 60-plus year history of the S&P 500 index. A 10% or more decline occurs about once every two years; a 5% about twice a year. Since the pandemic lows in March of 2020, the markets have been able to climb the wall of worry with nearly uninterrupted gains. This is not typical. Since late March 2020, the S&P 500 is up approximately 70% from the Covid bottom, making any selloff not only expected but long overdue. Markets are not linear and do not always go up.
The current decline is not from one specific event but a confluence of many. The Delta COVID variant spreading throughout the economy, the China Evergrande real estate default, a more hawkish tone by the Federal Reserve, a potential U.S. government shutdown, and surging inflation are all catalysts.
The economic environment is crucial to understand the economy and markets. The global recovery is ongoing as the data continues to improve. The current unemployment rate is 5.2% (August 2021) and is expected to fall further after peaking at 14.7% in April of 2020. Job growth has continued as monthly new job growth has averaged 586,000 since January. Initial jobless claims (newly unemployed) for the week ending September 25th were 362,000. The four-week average is now down to 340,000, another pandemic low but still above pre-pandemic levels. Continuing claims (longer-term unemployed) are also trending down to 2.802 million.
As of July, there were a record 10.9 million job openings in the U.S., as demand for labor continues. Currently, 8.4 million Americans are unemployed. This represents a 2.5 million worker shortage. To entice them, wages must increase as employers desperately compete to get those jobs filled. As well, with the supply chain challenges, whether chips or chairs, long supply delivery times are driving up retail prices and freight fees. These all lead to increasing inflation. However, as the supply issues fade, so will inflation.
The GDP estimate for 2nd Quarter was an annualized 6.7%, however, economic growth is expected to slow the second half of this year, then rebound early next year. Next year, supply chains are expected to be restored and assuming no more deadly variants, we could finally see a full economic recovery. Hence, last month, the Federal Reserve announced it will reduce its monthly bond purchases later in the year, and increase interest rates in late-2022, at the earliest. The U.S. economy no longer needs the emergency support that pulled it out of the global pandemic. Rates need to rise from zero…slowly.
The 12 months ending June 30, 2021 saw corporate earnings growth exceed 27% and sales grew more than 15% (S&P 500). This impressive, out-sized growth, however, followed a pandemic shutdown and corporate earnings collapse, and cannot continue through 2022. Several companies have continued to struggle due to the Delta variant, including many in travel & leisure.
In bonds, high yield corporates continued to lead in all periods. Tax-free was the worst performer for the quarter but they have provided a 5% annualized return over the past 3 years. They have also helped dampen volatility during this most recent decline. Aggregate bonds were the laggard year-to-date and 1-year, while cash was the worst performer in all other periods.
In equities, real estate led for the quarter, year-to-date, and 1-year, while large U.S stocks continued to lead in other periods. Small U.S. stocks were the worst-performing category for the quarter, while foreign stocks were the laggard in all other periods except the 5-year.
We do not expect market returns the next 18 months to resemble those of the past 18. Stocks are near all-time highs and volatility is back. The economy is still growing but the accommodations from the Federal Reserve and Congress are starting to unwind, so recent outsized returns will begin to normalize.