Quarterly Market Commentary: Q3 2021

There were a number of dynamics impacting markets throughout the third quarter, but when all was said and done, the S&P 500 ended the quarter relatively flat, returning +0.23%. This represents the sixth consecutive quarter of positive gains.

On the positive side, ongoing easy financial conditions, accommodative monetary policies, pent-up demand, corporate earnings much stronger than anticipated, corporate buybacks, and retail investor inflows all helped buoy the market. On the other hand, increasing concerns around peak policy, peak growth and peak earnings weighed on market sentiment. The spread of the Delta variant, which caused a larger spike in cases and has lasted longer than many had anticipated, led to negative revisions to economic forecasts and weighed on reopening momentum. Government shutdown and debt ceiling concerns also came to the fore towards the end of the quarter.

China developments worsened towards the end of the quarter, with embattled real estate developer China Evergrande Group struggling under the weight of $300 billion of liabilities. Concerns were elevated that a default could pose a broader systemic risk for the entire Chinese property sector and economy. However, our base case is that any potential default or restructuring will be closely managed by Chinese regulators to limit contagion for both financial and property markets. In no way does Beijing want to see any form of systemic risks unfold. Indeed, there has already been a negotiated agreement to restructure current notes outstanding with creditors.

S&P 500 earnings corporate earnings reported in July and August were historically strong. S&P 500 earnings were up more than 90% from the same period last year and the extent that companies beat consensus earnings estimates was at record levels. What’s more, companies across a wide range of industries highlighting a very strong demand backdrop and still elevated operating leverage and margins. With that said, more persistent supply chain and input price pressures were a common theme and led some companies to moderate their outlook for profits.

Bonds were challenged towards the end of the third quarter as yields rose. The benchmark 10 year Treasury ended the quarter at 1.49%, after hitting a low of 1.17% earlier in August. Despite the move higher in yields, core bonds ended the quarter relatively unchanged, with the Bloomberg Barclays Aggregate Bond Index returning +0.05% for the quarter. Much of the back-up in yields occurred late in the quarter and followed the Fed indicating it is likely to begin tapering its asset purchase program by the end of this year and that tapering is likely to be concluded by mid-2022. The Fed’s “dot plot” projections indicated FOMC members now believe the first fed funds rate hike may occur as soon as the end of 2022.

We are broadly constructive on the outlook for stocks, as we believe still accommodative policies may help to underpin ongoing appreciation, albeit at a moderated pace relative to that experienced earlier in the year. We also anticipate increases in volatility as the Fed’s accommodative policies wear off and we transition back towards a more “normal” stock market environment. We are well prepared for such an environment.

Recent Fed policies have arguably contained volatility since last year’s COVID driven March sell-off. But volatility is par for the course for the stock market: the average intra-year decline for the S&P 500 since 1980 has been -14.3% and stocks historically experience multiple sell-offs of -5% in any given year. Despite this – and more often than not – stocks tend to post positive returns: the S&P 500 has ended 31 of the last 41 years in positive territory. Indeed, we hold a positive long-term outlook for the stock market and believe any increase in market fluctuations may offer an opportunity, allowing us to more effectively rebalance across our client accounts.

We anticipate bond yields may move higher from current levels and have positioned our core fixed income allocations with less duration risk (interest rate sensitivity) than the broad bond market. We believe our fixed income allocations are well-positioned and our direct investment strategies may continue to generate attractive yield, low correlation to the stock market, and low levels of interest rate risk.

Overall, we continue to focus on long-term fundamentals and believe our portfolios are well-positioned to continue to meet the long-term financial goals of our clients.