October 2021

Key takeaways

► Stocks up, barely

► Bonds up, barely

► Inflation is top story

► Covid is still here

► Stick with stocks

Stocks and bonds eke out a gain

It didn’t feel like it, but the popular S & P 500 index of large US companies scored a sixth straight quarterly gain, up 0.58% in the third quarter. Smaller US stocks and international stocks lost ground. Fresh in memory, however, is how the quarter ended on a downdraft – the S & P 500 dropped 4.65% to end at 4308 in September, the worst monthly drop since the pandemic. Interestingly, the S & P also marked its all-time high in September, reaching 4535 on Friday, September 3. Slowing growth, rising inflation, supply bottlenecks, labor shortages, political gridlock in Washington, the coming end of Fed stimulus, and the threat of Covid all weighed on the market. Delta proved to be devastating in parts of the US, and inflation may not be that “transitory.” Yet, despite the turmoil in stocks, bonds barely moved. Bonds usually move in the opposite direction of stocks, and rising yields are often good for stocks. This time, bond prices were tamped down by inflation fears, which remains the market’s top worry.

(Two) Dollar Tree

Investors remain preoccupied with inflation. Prices have recently been rising faster than expected. As measured by year-over-year Consumer Price Index (CPI), US inflation reached 5.3% in August, the highest in decades. The monthly CPI number, along with the Labor Department’s employment report, remains one of the most anticipated statistics every month. For over a year, Fed Chair Jerome Powell has insisted that inflation is transitory, meaning that it will soon pass as the fits and starts of the post-Covid economy abate. However, Powell recently admitted that price increases have worsened due to snarled supply chains and rising labor costs. More importantly, what are expectations for higher inflation? Expectations of higher prices can be self-fulfilling as consumers rush out to buy before prices go up, causing demand to jump. A new survey from the Federal Reserve Bank of New York showed that Americans expect prices to increase over the next year. The New York Fed noted that in August, the median expectation for the rate of inflation over the next year increased to 5.2% – up from 4.0% in their survey in May. It’s the highest seen since the Survey of Consumer Expectations was launched in 2013.

The word “inflation” is getting much mention on corporate earnings calls too. FactSet said the term came up more than 220 times in S & P 500 earnings calls. Inflation doesn’t appear to be curtailing corporate profits – yet. When costs rise, companies have to either 1.) raise consumer prices, 2.) cut into profit, or 3.) both. For example, retail chain Dollar Tree, owner of Dollar Tree and Family Dollar stores, reported that rising costs would reduce profit-per-share by $1.50 to $1.60, as reported by Associated Press. CEO Michael Witynski admitted that some prices are going up. The company started testing higher prices, including a new store section called “Dollar Tree Plus,” where items can go as high as $5. Many customers welcome the more fabulous product assortment. Items priced at $1.25 – $1.50 are already interspersed in the aisles. “We will continue to be fiercely protective of that promise (of value) regardless of the price point, whether it is $1.00, $1.25, $1.50,” Witynski said.

The case for inflation:

• Savings continue to pile up.Americans continue to save! According to Euler Hermes North America, many are still cautious about things, and they are flush with cash – an extra $1.9 trillion. Savings grew during the pandemic when stimulus checks and lockdowns prevented eating out, travel, and even commuting. Although down slightly from early 2021, the personal saving rate in the United States amounted to 9.4 percent in August, according to the US Bureau of Statistics. The average in 1960 was 11%. As notorious as Americans are about their lack of savings, you know this is significant when we go back to 1960. All this money may eventually find its way into the economy – forcing a surge in prices.
• Dovish Fed. The Federal Reserve is maintaining its easy money ways. Fed Chairman Powell has stated that he is going to let inflation run higher for longer. Their average inflation target is 2%, meaning inflation will have to ride higher for longer to counter the many years below 2%. The average inflation rate since 2010 has been 2.08%. Minding its dual mandate to maintain stable prices and full employment, the Fed also hopes to decrease unemployment and achieve a measure of social equity by letting the economy run hot so that lower-income job seekers find jobs. However, recent inflation data is causing consternation among Powell and several Fed governors. Inflation may not be so “transitory” after all. Supply chain bottlenecks, labor shortages, and material costs may not decrease anytime soon.
• Scarce goods. A classic catalyst for inflation is too much money chasing too few goods. Materials from aluminum to steel have seen renewed rallies, and European gas and power have hit fresh records. Factories struggle to keep up with demand, especially for components like semiconductors needed in tech and auto manufacturing. The prices of several commodities, particularly oil, continued to move higher in the third quarter. The price of WTI crude oil is now over $75 per barrel!

The case against inflation:

• Nervous consumers. Despite flush savings, pent-up demand, and cabin fever, consumers may remain cautious about spending, worried about the highly contagious Delta virus strain and their jobs. So consumers notched down their spending on meals out, hotels and airline tickets. In addition, over four million Americans remain unemployed, and a poll from Monmouth University found that 1 in 5 Americans remain unwilling to get the Covid-19 vaccine. As a result, many Americans may wait a bit longer before venturing out. “Our consumers have lots of money in their checking accounts,” Bank of America CEO Moynihan said. “They have not spent about 65 [to] 70% of the last couple of rounds of stimulus.”
• Unemployment. Too many Americans are still jobless. According to the US Bureau of Labor Statistics, in August, the number of long-term unemployed (those jobless for 27 weeks or more) was around 3.2 million, representing 37.4% of all unemployed individuals – a drop from the pandemic high but still quite elevated. Enhanced federal unemployment benefits expired Labor Day weekend. It will be interesting to see how this will affect the employment situation through the rest of the year.
• New Covid strains. While the economy continues to improve, the coronavirus continues to mutate. Presently the new strains are called Delta and Lambda, and a new one may appear at any time. In addition, several parts of the world are experiencing severe outbreaks. Hesitancy to get vaccinated and a lack of vaccines in many third-world countries are not helping. All of this leads to a more hesitant consumer and makes for a shaky economic recovery.

We will probably see prices go up through this year and next as the economy works to meet demand and wages go up to lure workers back. However, investors, the Fed, and the White House are hoping for an eventual leveling-off or at least a very gradual increase in inflation in the next few years. Let’s hope they’re right.

Any alternative to stocks?

Investors sure have plenty to worry about in the fourth quarter: Slowing growth, rising inflation, supply chain disruptions, political gridlock, the end of Fed stimulus, and the persistent threat of new Covid strains are all hanging over the market. We can add a possible slowdown in China to the list too.

Nevertheless, stocks will likely continue their march forward through the end of the year and into 2022, propelled by strong earnings, strong growth, low interest rates, and, hopefully, continued progress in beating back Covid. Our economy is only mid-cycle (at most) in its present expansion. There’s plenty more rebound from 2020 to go. Inflation and what the Fed may do about it remain key risks in the future, but it’s hard to imagine the Fed raising rates aggressively anytime soon. And bonds are not attractive as their yields are negative after inflation. Remain diversified with a tilt toward stocks, particularly cyclical stocks in value sectors in small-cap and international. Continued low interest rates mean you don’t want to give up on your large growth stocks either. We will monitor President Biden’s ability to navigate his infrastructure plan through Congress as its passage will provide a significant boost to the economy. In addition, remember that, despite low rates and fears of inflation, it is essential to keep an appropriate amount in bonds. Bonds are like ballast in a portfolio. They provide income and protection in a stock market collapse.

Would you please let me know if you have any questions or concerns?

Enjoy the fall and coming holidays!

Sincerely, 
Henry 

Henry Gorecki, CFP® 
HG Wealth Management LLC 
10 S. Riverside Plaza, Suite 875
Chicago, IL  60606 
312-474-6496 
henry@hgwealthmanagement.com