Executive Summary

  • U.S. equities climbed in August for the seventh straight month, setting 53 new record highs along the way.
  • Fed Chairman Powell’s dovish comments at the Jackson Hole Symposium defended the Fed’s accommodative stance and reiterated their view of inflation as transitory.
  • Individual household balance sheets are the healthiest they’ve been in decades, implying that consumer spending could be robust well into 2022.
  • Large Cap Growth sectors have outperformed recently amongst the backdrop of lower interest rates and the Delta variant resurgence.

What Piqued Our Interest

A confluence of factors helped drive the U.S. equity market higher for a seventh consecutive month—the longest winning streak since January 2018. Despite the renewed fears stemming from the Delta variant and China’s regulatory crackdown, stocks climbed higher based on a robust earnings season, strong cash inflows, and a dovish Federal Reserve, which ensured that easy monetary policy isn’t going away any time soon. For the better part of the summer, investors eagerly awaited the annual Jackson Hole Symposium for any signs of change to the central bank’s policy, which has significantly boosted stocks and other risky assets since the peak of the pandemic. The meeting was held virtually in late-August with little fanfare, but the expected outcome was well-received by market participants.

Despite the symposium largely being a non-event, there were some key takeaways from Jerome Powell’s speech. First off, the Chairman defended the Fed’s accommodative policy despite the recent boost in inflation. According to the U.S. Bureau of Labor Statistics, core CPI inflation surged 4.3% year-over-year in July—significantly higher than the Fed’s 2% target, as well as their own estimates earlier this year. Headline inflation, which doesn’t exclude the Food and Energy sectors that tend to be more volatile, increased 5.4% in July. Powell has remained steadfast that the recent increases are transitory in nature, based upon low base effects and unique and temporary supply-demand imbalances from the pandemic. Citing specific examples, much of the uptick in inflation has occurred in a narrow band of sectors—particularly related to Transportation, as well as Travel and Leisure. It’s also noteworthy that some of the materials that shot up in price earlier this year have come back to earth, with lumber being a prime example. On the flip side of Powell’s argument, wage growth has been increasing as of late, as average hourly earnings grew 0.6% in August and 4.3% over the past 12 months—higher than expectations and well above trend level. Wage inflation tends to be stickier in nature and can be an indicator of more structural inflation in the months ahead.

Figure 1. Core CPI (ex. Food & Energy) – Year-Over-Year Percent Change

core cpi

Source: BSI, FactSet as of 8/11/2021

Perhaps the key question for investors coming out of Jackson Hole pertains to when the Fed will curtail its bond purchasing, more commonly referred to as “quantitative easing.” The Fed has been buying $120 billion in bonds monthly, but with fears of market bubbles rising and inflation concerns mounting, it is fair to wonder if continuing the program will do more harm than good. Based on Powell’s comments, tapering (buying fewer bonds but not stopping altogether) may begin by the end of the year, depending on current economic conditions. Powell also made it clear that the criteria for tapering and raising rates are on different levels, meaning that just because we may see the Fed’s balance sheet start to level off, don’t expect to see a higher Fed Funds Rate any time soon.

This talk of tapering reminds us of 2013, the most recent episode in which then-Fed Chair Ben Bernanke caught investors off guard when he spoke of taking his foot off the monetary pedal. Observing how stocks and interest rates behaved in the following months may give us some insight as to what lies ahead this time. According to FactSet, after the May 22 announcement in 2013, the S&P 500 fell 6% the month after but ended up 11.7% from that date to when tapering began in earnest in January 2014. Other developed countries fared well during the taper tantrum of 2013, however, emerging markets were among the biggest losers, falling -6.7% over the same span. Meanwhile, the yield on 10-year Treasuries, which had been declining, began climbing in anticipation of the taper announcement. The 10-year went on a run from roughly 2% in May to 3% in January 2014, only to begin another steady decline once the tapering actually began. Despite the belief that Fed purchasing was keeping rates low, it is clear that the signaling by the Fed had an even more profound effect.

Looking forward, regardless of what the Fed announces in the coming months, it is clear to us that we may still have several months of robust economic growth ahead of us. Consumer balance sheets are the healthiest they’ve been in decades as a result of stimulus payments, higher savings rates, and the low interest rate environment, which has boosted the housing market and helped owners refinance. The total U.S. household debt service ratio, which includes credit card and mortgage balances, reached just 8.2% in the first quarter of 2021—by far the lowest on record over the past 40 years. Along with a rapidly improving labor market, this bodes well for consumer spending, which makes up roughly 70% of GDP and is expected to increase roughly 9% year-over-year in the fourth quarter, according to Cornerstone Macro. While consumers spent a majority of the post-global financial crisis cycle deleveraging, they are now starting from a more favorable backdrop, which should boost spending across all demographic segments well into 2022.

Market Recap

september recap

According to JP Morgan, retail investors bought equities at a record pace over the summer months, as year-to-date (YTD) global equity fund flows into equities are almost $700 billion—or over $1 trillion if annualized. The previous record for equity flows stood at $629 billion in 2017, which has already been surpassed. In addition to the retail frenzy, corporate buybacks are once again on the rise, which has been a clear tailwind for stocks. The “buy-the-dip” mentality has been pervasive and helps explain why we haven’t seen a drawdown of 5% or worse this year. Goldman Sachs recently reported that companies in the S&P 500 have authorized more than $680 billion in buybacks through July—the second highest total on record. As companies curtailed their buyback programs last year, there is close to $2 trillion in cash and short-term investments held within the S&P 500, signaling that there could be plenty more buyback and dividend increases to come.

All of this helped drive the S&P 500 higher by 3.04%, as the Large Cap Index has now recorded 53 record-highs this year—the most ever recorded through August. According to Morningstar, the Index has gained over 21.5% YTD through August, now handily outperforming the Small Cap Russell 2000 Index, which had been in front most of the year. Still, at +15.83% YTD, not too many investors would shrug off those impressive returns through eight months. As the summer months rolled on and concerns about the Delta variant mounted, the Growth-over-Value trade continued to prevail as the Russell 1000 Growth Index surpassed the Russell 1000 Value Index for the first time since January. Growth-oriented sectors such as Consumer Services (+5.01%) and Information Technology (+3.56%) were among the best-performing last month, while Energy fell -2.04% and is no longer the leading sector YTD. The top-performing sector in August was Financials (+5.14%), which is also higher by 31.57% in 2021, trailing only Real Estate (+32.64% YTD) as the top-performing in the U.S. this year.

International equities climbed overall, as the MSCI EAFE Index, which tracks developed countries, increased by 1.76%, or 11.58% YTD. The Emerging Market Index fared better at +2.62%, but it was simply making up ground after previous negative months. The MSCI EM Index was roughly flat on the year prior to August after Chinese equities tumbled over the summer but is now higher by just +2.84% YTD. The MSCI China Index is still -12.26% this year after a flat August, while the Japan Index is also barely in positive territory at +3.07% YTD. Other notables in August include India (+10.94%) and Taiwan (+4.47%), both of which are now up more than 20% in 2021. The U.S. dollar edged higher, as the index gained half a percent last month and is up almost 3% on the year, despite the U.S. experiencing higher inflation relative to most of the developed world.

Flipping to fixed income, the Bloomberg/Barclays U.S. Aggregate Bond Index fell again last month and is now lower by -0.69% on a total return basis. The 10-year Treasury crept higher by just five basis points, ending the month at 1.28%. Spreads across the fixed income spectrum remain incredibly tight, as the high-yield index fetches just 3.31% in additional yield relative to the 10-year Treasury, which is almost a full standard deviation lower than the 20-year average of around 5.3%. The Bloomberg high-yield index did gain 0.51% in August and is one of the top-performing bond sectors YTD at +4.55%. Inflation-linked bonds were slightly negative after running higher earlier this year, as the Bloomberg TIPS Index still reflects a total return of +4.26% YTD. The municipal index fell in line with the U.S. aggregate index but is still outperforming even on a pre-tax basis (up 1.53% YTD).

Final Thoughts

The market has been on an impressive run this year, and the post-Jackson Hole environment, supported by the Fed’s dovish comments, should continue to be positive for risky assets. As we have for most of this year, however, we still have our concerns surrounding stretched valuations, COVID-19-related economic restrictions, China’s regulatory practices, and rising inflation fears, all of which have the potential to create volatility in the months ahead. None of these issues appear to be going away anytime soon, but as long as the “Fed Put” remains in place and the economy continues to grow at a record clip, the path of least resistance for the broader equity market appears to be higher.

This doesn’t mean that the path won’t be rocky at times. Remember when everyone was piling into SPACs earlier this year? Special Purpose Acquisition Companies, a.k.a. “Blank Check Companies,” are essentially publicly traded shell companies designed to help many startups turn public, and they attracted record inflows in the early months of 2021 as investors were chasing quick double- and even triple-digit returns. The Wall Street Journal reported in August that the cumulative value of companies that completed SPAC mergers by mid-February have now lost 25% of their combined value—erasing $75 billion in market value (during a period in which the broad market is up over 20%).

This isn’t to say that investing in a particular SPAC is automatically a bad idea, but rather it is a reminder of why filtering out the noise and investing with a strategic focus is imperative for reaching one’s goals. We believe in time-tested strategies and investment discipline as the keys to long-term success, regardless of the economic climate.

 

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