Executive Summary

Uncertainty surrounding the U.S. debt ceiling, inflation concerns, disappointing economic data, and multiple issues in China helped break the S&P 500’s seven-month winning streak in September. While it’s becoming clearer that peak growth of this economic recovery may have already occurred and the transitory surge in inflation may last longer than originally expected, the near-term cyclical outlook remains strong, despite the current headwinds.

What Piqued Our Interest

Believe it or not, the fourth quarter of 2021 is already upon us, and there are no shortage of headlines and concerns for the market to grapple with. For starters, while the U.S. government narrowly avoided a shutdown via a stopgap funding bill, political debate over raising the U.S. debt ceiling once again has investors and the general public on edge. The implications are huge for obvious reasons: If we don’t raise the debt ceiling, the U.S. could default on its payments, potentially resulting in a credit downgrade, loss of credibility, and a downward spiral into another recession.

As of October 7, Republicans and Democrats are still working out details of a temporary fix that would raise the debt ceiling by roughly $200–400 billion until December. Even as lawmakers effectively kicked the can down the road, the political posturing has unnerved markets to a degree, and uncertainty may loom for months to come. The situation is eerily similar to August 2011, when the U.S. experienced its first and only credit downgrade over the same debt ceiling debacle. From the days leading up to the 2011 downgrade through October of that year, the S&P 500 fell over 20%, while the CBOE Volatility Index surged from around 15 to 48 as investors panicked. Given the brinksmanship and heightened partisanship surrounding the pending infrastructure legislation, we take today’s situation very seriously, and while we don’t think the government will ever default on its debt, the market hates uncertainty, which has clearly risen in recent days.

Another disconcerting observation has been the downward trend of economic data failing to live up to estimates. The Citi Economic Surprise Index helps demonstrate how realized economic data compares to expectations, and while the economy significantly surprised to the upside in the second half of 2020, in recent months, the index has turned negative as the Delta variant, rising inflation, the U.S. debt ceiling, and myriad dilemmas in China have all weighted heavily on economic results.

citi eco surprise index

Source: FactSet

Another way to view the descending trajectory is by monitoring Bloomberg’s consensus estimates for third quarter GDP, which has dropped from around 6.7% in July to 5.5% in October. At the same time, the Atlanta Fed’s GDPNow estimate for Q3 (which, admittedly, is more volatile) has fallen from 6% on July 28 to about 1.5% on October 6. As economic data has disappointed and the U.S. debt ceiling dilemma looms, yields have once again been on the rise. According to Bloomberg, the 10-year U.S. Treasury ended the month at 1.47%, up from 1.29% at the start of the month and as low as 1.18% in early August. Perhaps also to blame, rising inflation expectations remain top of mind, as supply chain challenges continue and consumer demand remains elevated.

Equally important, consumer’s short- and intermediate-term expectations for inflation have risen considerably, which may help perpetuate rising prices in a self-fulfilling manner. The New York Fed’s August survey showed that median one-year-ahead inflation expectations increased to 5.2% in August—the tenth consecutive monthly increase and a new series high. While the Fed has remained steadfast that the current rise in inflation is transitory in nature, the new question on everyone’s mind is how long this transitory period might last, as it has already surpassed many estimates from earlier this year.

On the note of China, the country’s manufacturing purchasing manager’s index (PMI) fell to 49.6 last month, according to the National Bureau of Statistics in Beijing, marking the first move into contraction territory since February of 2020. Shipping disruptions, a global semiconductor shortage, increasing regulatory restrictions, surging commodity prices, rolling power outages, and a weakening real estate market—highlighted by the Evergrande debacle—have all been to blame for the downturn. While we don’t believe that Evergrande’s ongoing debt crisis represents a “Lehman moment” from a contagion standpoint, the company is one of the largest in the world from a revenue standpoint, and real estate represents roughly 30% of GDP in the country, so further caution remains warranted.

Market Recap

october recap

All these concerns resulted in the S&P 500 breaking its monthly winning streak in September, however, the index still ended higher for the sixth straight quarter—albeit just barely. The market rose 5.5% during the quarter and then gave nearly all of it back in the final weeks, closing with a gain of just 0.2%. For the year, the Large Cap U.S. Index is still positive by 15.92%, even after falling -4.65% in August. Small Caps fared slightly better last month, only falling by -2.95% and are still the top-performing equity category over the past 12 months at +47.68%.

For the first time since May, the Russell 1000 Value Index outperformed Growth, as higher interest rates stymied longer duration growth sectors such as Technology and Communication Services. Of note, several of the high-flying “Big Tech” stocks such as Apple, Amazon, Facebook, etc. all saw outsized losses during the month. Materials, Real Estate, and Industrials were also hit hard, while Energy was the only positive GICS sector, up a whopping 9.44% in September and 43.22% year-to-date (YTD). Energy stocks rose on the back of a surging commodity market, which is now trading at its highest level since 2011. In the U.S., oil prices rose to their highest level since 2014, as OPEC+ recently declined to increase production amidst a surging global energy crunch. Meanwhile, bonds fizzled once again, primarily due to the imminent debt ceiling crisis unfolding, as the Bloomberg Barclays U.S. Aggregate Bond Index fell 0.87% in September.

commodity spot index

Final Thoughts

Historically speaking, this time of year has been ominous for markets for a number of reasons, and 2021 so far has fit the billing. Looking forward, it is becoming more evident that economic growth may have already peaked this year and that the transitory surge in inflation may last longer than previously expected. However, the near-term cyclical outlook is still very strong, as companies and sectors associated with the reopening of the economy may still benefit for months to come—particularly as the worst of the Delta variant moves to the rear-view mirror. We expect the Fed to formally announce their tapering plans this quarter, while the actual tapering will probably begin before year-end. Given the Fed’s tendency to overcommunicate, the actual reduction in bond purchases should have a limited effect on the market. A hike in interest rates by the Fed is likely still more than a year away, as Jerome Powell has cited a “substantially more stringent test” for raising rates as opposed to tapering. In the meantime, more attention will be paid to the “dot-plots,” which suggest where the Fed sees interest rates in years ahead, for any sense of forward guidance.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Gary Quinzel

Gary Quinzel

Senior Portfolio Manager

MBA, CFP®, CFA® Gary began his career in investment strategy and management in 2003. He is highly-skilled in the areas of macroeconomic research, portfolio management and investment analysis. Gary also enjoys delivering market commentary and guidance to clients. He lives in Morris Township, NJ with his wife Andrea and their daughter Avery. In his free time, you will find Gary spending time in the outdoors, running and playing sports. MBA, Seton Hall...Read More