On the one hand, I am excited to start this commentary with something other than the latest COVID-19 stats, but on the other hand, some of the issues we now face might be just as concerning. First, global supply chain issues have caused shortages of everything from food to cars and are a significant contributor to inflation numbers last seen in the 1970s. Second, at some point, the Federal Reserve (the Fed) will raise rates, and what effect will that have on the markets? Finally, while Congress agreed to raise the debt ceiling and fund the U.S. Federal government, it was a short-term agreement, and we might be looking at a showdown in December. However, not all news is bad news as the world is returning to normal as we learn to live with COVID-19. Everyone seems to be traveling again, sports are being played in full stadiums, and 98% of schools are back to in-person learning.
While the direct effects of COVID might be lessening, the secondary effects still pose a risk to the global economy. A chain is only as strong as its weakest link, and as it pertains to the current state of the global supply chain, weakness is everywhere. Massive dislocations are present in the container market, shipping routes, ports, air cargo, trucking lines, railways, and even warehouses. The result is a shortage of crucial manufacturing components, order backlogs, delivery delays, and a spike in transportation costs and consumer prices. Supply chain issues are the main reason why inflation is up over 5% in 2021. There is no consensus among economists and supply chain experts on when supply chains will regain a sense of normalcy. The longer these prolonged disruptions persist, the bigger risk they pose to the post-COVID-19 recovery.
Interest rates will increase. This is not a bold prediction as the federal funds rate is currently only 0%-.25%. The federal funds rate is the rate set by the Federal Open Market Committee, and it is the target rate at which commercial banks borrow and lend their excess reserves to each other overnight. The federal funds rate has a significant influence on rates in the broader economy. While the Fed may raise rates due to a strong economy, rates that rise too fast can lead to volatility in the stock and bond market. Simplistically, if the interest paid on a new bond is higher than the interest paid on an older bond, the value of the older bond will drop. Additionally, some investors’ appetite for the risk associated with stocks decreases as the predictable return available in fixed income increases. This can create a rotation from equity investments to fixed investments. This rotation can potentially cause a sell-off in the stock market, but that is not always the case as sometimes the growing economy (the reason rates are going up) helps push stocks higher.
Writing about decisions out of Washington can be about as much fun as discussing a pandemic, but it must be addressed. Many of you asked for our opinion on the debt ceiling and how it might affect the markets. As we expected, a short-term deal was reached to fund the federal government through December 3rd. Shortly after this agreement, both parties began their posturing as to what would happen next. While there are no certainties when speculating about what politicians will do, most believe that the debt limit will be increased again in December. The risks of defaulting on our debt are too great. Additionally, Congress is debating an infrastructure bill, a $3.5B spending bill, and possible tax changes. We continue to follow these essential items and their effect on the market and the economy.
While there are reasons to be cautious about the market, overall, 2021 has been a good year. U.S. stocks continued to post slight gains in the third quarter, even with a September that was the worst month since March 2020. Large cap stocks (generally defined as companies with a market capitalization of more than $10 billion) were up only 0.43% for the quarter but are still up 14.68% for the year as measured by the Standard and Poor’s 500 (S&P 500). Small cap stocks (generally defined as having a market capitalization of less than $2 billion and measured by the Russell 2000 Index) were actually down 4.60% for the quarter but are still up 11.62% year to date. International and emerging market stocks have not fared as well, with international stocks down 0.60% for the quarter and up 8.3% year to date as measured by the MSCI EAFE Index. Emerging market stocks have experienced headwinds in 2021, especially in the third quarter, which saw them down 8.1% and are now down 1.2% for the year based on the MSCI Emerging Market Index. In anticipation of rising interest rates, fixed-income investments (bonds) continued to face pressure. The Barclays Aggregate Bond Index gained only 0.10% for the quarter, bringing its losses to 1.60% for the year.
It feels like the stock market is in somewhat of a tug of war right now. While third quarter corporate earnings are expected to be strong, it is unclear how much of that is already in the stock market gains year to date. We have an economy growing at over 6.8% annualized when measured by GDP, but we have the three concerns outlined earlier: global supply chain disruptions, rising interest rates, and the debt ceiling. Often, a tug-of-war environment leads to more volatility, and until September, this had not been the case in 2021. Before September, we had not seen a market drawdown of 5%; we usually have three per year. While one cannot know what the stock market will do in the short term, our opinion has not wavered for the long term. The best way to meet your long-term financial goals is with detailed financial planning combined with a well-constructed, diversified portfolio.
The views and opinions expressed are of Persium Advisors, LLC. This commentary is provided for educational purposes only and should not be construed as investment advice. Persium Advisors is an investment advisor firm located in Atlanta, GA.
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