High Level Commentary

MARKET PERFORMANCE-As Of September 20, 2021

CI Hi Level Perf 210920

Short-Term Positive:

-The $1 trillion infrastructure package continues to have bipartisan support, but the potential  linkage to the $3.5 trillion bill is hampering the passage of the infrastructure bill.  If this bill is passed, the funds will be spent over a number of years.  Economists believe that this spending has the potential to increase economic growth and productivity.

-The $1.9 trillion government stimulus package passed in March is causing significant upward revisions to economic growth forecasts.  For example, the Federal Reserve revised their 2021 economic growth forecast on June 16th to 7.0%, up significantly from their 4.2% December forecast.  If this growth rate holds, it would be the highest economic growth rate since 1983.

-Some of the stimulus dollars are moving into the markets.  This provides short-term investment demand to push prices higher.

-COVID-19 vaccines brought an end to most U.S. shutdowns.  There continues to be concern regarding the impact of the Delta variants, especially in emerging markets with low vaccination rates.

-Pent-up savings, pandemic constrained spending and pent-up demand should increase near-term economic growth.

-FactSet 2021 Q2 corporate earnings consensus expectations for the S&P 500 continue to rise, and are now expected to rise 64%, compared to last year when the pandemic caused broad-based shutdowns.  2021 full-year earnings are now seen moving up 35.6% compared to 2020. 

-Investment performance for 2020 was led by technology, but performance has broadened out in 2021.  The “Reflation Trade” favors energy, industrial and financial companies that are both cheaper and that offer more upside as the economy recovers.

-Some investors believe we are in the early stages of a new bull market and are describing the current market environment as the “Roaring 20s.”  This optimistic perspective is based on sustained upside to economic growth and corporate earnings.

Short-Term Negative:

-Evergrande is a Chinese property developer that is facing a default on its $300 billion debt.  The market fears “contagion” that spreads throughout the Chinese economy and international markets.  Optimists believe that the Chinese government will intervene to prevent any collapse.

-The current $28.5 trillion U.S. debt ceiling needs congressional action by mid October.  Political brinksmanship is likely before passage of another continuing resolution.

-The Delta COVID variant has slowed both manufacturing and service industries in the U.S. and globally.  China is particularly negatively impacted.  

-Consumer inflation is increasingly reflected in current data with the August Core Consumer Price Index up 4.0% over the last 12 months.  Federal Reserve officials say any inflation will be “transitory”, but history shows that inflation is hard to contain after it has gained momentum.  The market is very concerned that inflation may prove to be more than transitory.

-The Federal Reserve’s so-called “Dot Plot” forecast on June 16th showed the Fed raising short-term interest rates twice towards the end of 2023.  Previously they had communicated raising rates in 2024.  The market is also concerned about when the Fed will begin tapering their $120 billion monthly purchases of treasury and mortgage bonds.  

-Asset inflation (both stocks and bonds) has pushed market prices above average fundamental valuation levels.  Valuation levels are particularly expensive for U.S. stocks and long-maturity bonds.

-The Federal Reserve’s monetary stimulus has kept interest rates low but it distorts markets by shifting investors towards risky assets.

-The second quarter ending June 30th can be characterized “as good as it gets.”  Although economic growth and corporate earnings remain strong, future growth rates will no longer be compared against the pandemic-induced shutdown but rather against tougher historic comparisons.    

-Speculative red flags include GameStop, Bitcoin, AMC, Tesla and the proliferation of SPACs.  This speculative demand is driven in part by increased retail demand and especially investors who are confusing gaming with investing.  Current speculative momentum could reverse quickly.

U.S. Economic Statistics Remain Positive but inflation concerns are increasing.  Economic statistics dropped precipitously due to the government-induced shutdown in 2020, but then rebounded well above consensus expectations.  Most recently, economic reports are showing accelerating growth. 

-US Second Quarter 2021 GDP moved up 6.5% on an annualized basis.  This was a good report, but it was modestly below consensus expectations.  Consumer spending was up 11.8%, partially due to stimulus checks. 

-Unemployment (at a 50-year low of 3.5% in February 2020) spiked to 14.7% as the pandemic shut down the U.S. economy, but has since dropped to 5.2% for August.  Job creation for August came in at a discouraging  235,000 due largely to renewed COVID restrictions.  

-Retail sales plunged as the pandemic shut down U.S. consumers with a-14.7% decline in April 2020, the largest decline since 1992 when this data series was initiated. However, retail sales have rebounded significantly due to gradual reductions of lockdowns and government stimulus checks.  Retail sales were up 0.7% in August 2021, and consumer spending continues to help support the economy.  U.S. households accumulated over $2.5 trillion in excess savings during the pandemic, and this should drive strong consumer spending through 2021.

-Industrial production advanced 0.4% in August despite a shortage of semi-conductor chips that continues to constrain domestic car and light truck production.

-Housing has been strong due to low mortgage rates, but new construction is currently negatively impacted by rising mortgage rates and rising lumber costs.  Fortunately, lumber prices have come down recently.

-Inflation has been low, but is increasing.  The Core Consumer Price Index came in at trailing 12-month rate of 4.0% annualized rate in August.  The Core CPI is down modestly from July, but it remains troubling and is at the highest level since November 1991.

-The Leading Economic Indicators came in at a positive 0.9% in July, the fifteenth consecutive monthly gain.  When the pandemic first hit, the data was negative with March down -7.5% and April down -6.3%. These statistics showed a sudden, large shutdown of the U.S. economy caused by the unprecedented coronavirus pandemic.  Since that time, the U.S. economy has recovered much faster than expected.

-The European Union has revised upward their 2021 GDP forecast to 4.8%.  The EU is forecasting 2022 GDP at 4.5%.  The EU contracted 6.0% in 2020 due to the pandemic.

-Japan’s 2021 Q1 GDP came in at a -1.3% quarter-over-quarter level due to widespread COVID-19 lockdowns that crimped consumer spending.  Japan is expected to recover in the second quarter, and the consensus expectation is for a 3% 2021 GDP increase compared to 2020. 

-China reported 2021 Q2 GDP growth at 7.9% with solid gains for manufacturing and consumer spending.  China appears to be regaining economic momentum.

Performance:  U.S. stock indexes moved up to record-high levels based on government stimulus and optimism with COVID-19 vaccine.  The positive news related to the rollout of vaccines shows that the market is pricing in better prospects for the economy and corporate earnings.  Energy, industrials, financials and small cap stocks have outperformed in 2021as the market rotated away from some of the tech darlings, but the higher growth sectors have recently regained momentum.  Small cap stocks are cheaper and have more earnings upside as the economy recovers from the COVID-19 lockdowns. 

Although bonds were positive in 2020, longer maturity bonds have underperformed in 2021.  While fiscal stimulus is necessary as we face the COVID restrictions and lockdowns, there is a growing concern related to potential inflation and to huge government budget deficits.  Investors are less willing to accept historically low longer-term government debt, and this is pressuring long-maturity bond prices lower as yields move higher.

GameStop, Bitcoin and Dogecoin have been big performers.  Retail investors have added volatility to speculative stocks in 2021.  They first targeted Gamestock.  They initially drove the stock up as they purchased the stock and call options on the stock, forcing hedge funds with short positions to cover their short positions.  Investors with short stock positions essentially borrow stock and then buy it later to close out their positions.  Investors take short positions when they expect the stock to decline.  GameStop has been a favorite stock to short because it is a bricks-and-mortar video game store with declining revenue and profits.  Short positions on stocks can be lucrative if stocks decline sharply, but are very risky when stocks rise.  Retail investors used Reddit’s WallStreetBets, web site to coordinate stock and call option purchases as they encouraged one another to upset the Wall Street status quo.  This was described as a David and Goliath story.  Although many retail investors achieved huge short-term gains and have forced huge losses on the hedge funds with short positions, there is little fundamental reason to hold these stocks on a long-term basis.

Markets have also reacted positively to President Biden and the previously passed $1.9 trillion stimulus bill.  The market is also taking a positive view of the President’s downsized $1trillion infrastructure plan.  Although the President has secured sufficient support from the U.S. Senate, the House may not agree to the plan without additional social programs.   

Market valuations remain rich.  At this point, markets are trading on accelerating 2021 earnings.  Various valuation metrics (like Price/Earnings ratios) for 2021 are still elevated.  It is important to remember that valuation doesn’t predict short-term performance, but valuation definitely impacts long-term performance potential.  In other words, markets could continue to get move up on a short-term basis, but the longer-term performance might be a 5-7% average long-term return/year rather than the historic 10%/year return.

Stimulus packages helping in the short run, but debt keeps growing.  Three stimulus bills have been enacted since the beginning of the pandemic in March 2020.  These bills are summarized below: 

-The $2.2 trillion CARES Act, passed quickly in March 2020, provided $1,200 direct payments and enhanced unemployment benefits.  

-The $900 billion Pandemic Relief Bill passed in December 2020.  This provided $600 in direct payments to eligible individuals and $300/week in extended unemployment benefits through March 2021.

-The $1.9 trillion American Rescue Plan passed in March 2021.  This plan included $1,400 direct payments to most Americans and extended additional unemployment benefits through the summer. 

The Biden administration is proposing a $1.2 trillion American Jobs Plan for infrastructure and other spending, and also a $1.8 trillion American Families Plan.

The U.S. federal debt stands at $28 trillion, and is expected to continue to grow for the foreseeable future.  Although current interest rates remain low, future inflation could cause rates to rise, and this would cause sharply higher debt service costs.  This is clearly a headwind on a longer-term basis.

For more detail see:

Markets & Economics

Market Performance


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