Third Quarter Market Review
Contributed by: Brad Meeks, CFA
“First and foremost, don’t even think about trying to extrapolate macroeconomic, demographic, and political events into an investment strategy. Say to yourself every day, “I cannot predict the future, therefore I diversify.”
– William Bernstein, MD, PhD. from the book Rational Expectations: Asset Allocation for Investing Adults
Bill Bernstein’s quote provides a great reminder of why diversification is one of, if not the most, important tenet of investing. Last year at this time, markets were making a historic comeback post-Covid, rallying off the March lows. However, concerns going into a Presidential election were starting to cause uncertainty about the future given potential fiscal policy changes under a new administration. Flash forward to this year, a new administration is at the helm, fiscal policy changes are in the headlines, yet the first two months of this quarter were relatively smooth sailing with equity markets churning towards new all-time highs. Sectors that have led the market in previous quarters took a back seat, as Financials, Communication Services, and Technology names were particularly strong relative to Industrials, Materials, and Energy companies, which lagged. From a style perspective, growth-oriented companies provided the second straight quarter of outperformance relative to value names, as fears of a deceleration in economic activity shook markets given the rise of the Delta variant. The month of September provided a much different environment for equity markets relative to the first two months of the quarter as the S&P 500 posted its first monthly decline since January, down almost 5%.
For much of 2021, the path of equities has been higher, with no less things for the market to worry about. Markets shrugged off most headline risks as items to think about for another day. September ushered in that backdrop, as the optimistic Summer months faded into “known concerns,” which caused markets like the S&P 500 to sell off, or at a minimum to take a pause from the greater than 20% return through August. To put this year into perspective, the S&P 500 has increased 16% year to date, while the tech-heavy Nasdaq and Dow Jones were no slackers, up 13% and 12%, respectively. Despite this quarter’s ups and downs, the S&P 500 recorded its sixth straight positive quarter with a 30% return over the last year!
While equity markets were mixed, the September Federal Reserve meeting gave hints that a more formal announcement at the November Fed meeting could include more explicit direction around the Fed pulling back the punch bowl on its $120 billion per month stimulus it’s provided to markets. The last few weeks of the quarter saw U.S. Treasury yields adjust to this information, as the 10-year bond pushed over 1.50% and the 30 year bond over 2.00%. While these figures are still historically low on an absolute level, similar bonds were priced as low as 1.1% in early August, making their rapid rise notable on a percentage basis. Fixed income markets are grappling with whether inflation is, in fact, “transitory” as the Fed has claimed or if it’s more persistent. If it’s the latter, fears of stagflation (low growth with high inflation) would be a worrisome trend. The rise in rates seemed to correspond with the Fed’s commentary that rising input prices are still transient given supply chain bottlenecks coming out of the Covid period. Be it as it may, Chairman Powell did acknowledge that those higher input prices have lasted longer than they originally thought, putting pressure on fixed income returns year to date.
As we enter the fourth quarter of the year, concerns around the Federal Reserve’s tapering plans, Washington D.C. drama from the debt ceiling debates, persistent supply chain restrictions, rising energy costs, and a slowing recovery due to a resurgent coronavirus are now the issues of the day. While several economic figures missed consensus expectations, there is plenty of liquidity in the markets, which could continue to support equities as we finish the year. Markets are in the process of adjusting to the “new normal” as we grapple with economic normalization post-Covid.
Bill Bernstein’s quote (and much of his research on financial markets) is a wonderful reminder of why we create all-weather portfolios for our clients. Any given quarter can provide a shock for investors—or none at all. We have no particular insight into whether a market correction will happen, unlike many market pundits who claim it’s right around the corner. It very well could be. After all, a broken clock tells the correct time twice a day. Nevertheless, our experience with financial markets always leads us back to Bill’s comments that predicting the future based on elements out of our control is unwise and usually leads to poor outcomes. Focusing on what we can control—our investment discipline, our emotions, and a long-term investing horizon, takes the guesswork out of predicting the next “worry” the market will focus on any particular day, week, or quarter.
As always, we appreciate your continued trust in Madison Wealth Management.