2021 Third Quarter Review and Outlook
In the third quarter the S&P 500 Index returned a modest .58%. The index is still up 15.92% in 2021 after a very strong first half of the year. Stocks lost momentum in September due to concerns over the Delta variant, rising inflation, supply chain problems, policy changes in China and uncertainty in Congress. In July and August, interest rates dropped as the market seemed to dismiss concerns about inflation. In September, interest rates climbed as the market started adjusting inflation expectations. We still expect inflation to be higher and last longer than the current consensus projections. We continue to favor inflation-hedging assets and recommend that most clients stay closer to the higher end of their equity allocation, as long as this strategy is within a client’s risk tolerance.
The start of the third quarter saw interest rates drop as the market seemed to be pricing in inflation as a short-term (transitory) problem. In July the 5-year U.S Treasury yield dropped from .87% to .65% and the 10-year U.S. Treasury yield dropped from 1.45% to 1.19%. At the same time, companies continued to experience supply chain problems and labor shortages and energy prices increased to multi year highs. In September Federal Reserve Board members released their updated economic assumptions. They raised their Personal Consumption Price Index inflation projection from 3.4% to 4.2% for 2021. The Federal Reserve also set the stage for a November announcement to begin tapering their $120 billion in monthly asset purchases. These developments led to a quick increase in interest rates at the end of the third quarter. The 5-year U.S. Treasury yield ended the quarter at .98% and the 10-year U.S. Treasury yield ended the quarter at 1.52%. Current yields are less than the Federal Reserve long term inflation target of 2% and we expect interest rates to continue to grind higher in the fourth quarter. Fixed income, as measured by the Barclays U.S. Aggregate Bond Index, returned .05% for the third quarter and -1.55% for the year. Given the poor risk/reward potential that most bonds offer, we continue to recommend shorter term bonds and matching maturities with upcoming cash flow needs.
Adding to the volatility of the third quarter were developments in Washington D.C. At the end of September, Congress agreed to keep the government funded averting a shutdown during the pandemic. There is still posturing about raising the debt ceiling, but we expect Congress to eventually reach an agreement at the last minute and see this event as a short-term risk with minimal long-term consequences. The biggest development out of Washington has been the stalled Build Back Better Democratic plan – with a price tag estimated around $3.5 trillion. Disagreements between Democratic moderate Senators and progressive House members has led to a stalemate for the Build Back Better plan and the $1.1 trillion infrastructure plan that already passed the Senate. If neither bill is passed by Congress, this would be a short-term negative to have less money pumped into the economy, but a long-term positive for the markets to have lower taxes and less deficit spending. We continue to monitor developments in Washington, especially the possibility of higher corporate and personal income tax rates, and their impact on the economy.
Concerns about the Delta variant hurt companies tied to the reopening of the economy (travel and leisure stocks). Fortunately, we appear to be past the peak of the Delta variant and Merck reported very strong test results for their covid pill. These developments should be positive for the economy, future corporate earnings and the stock market. Large Cap stocks outperformed other asset classes during the quarter. The S&P Mid-Cap Index returned -1.76% for the third quarter and 15.52% for the year. The S&P Small Cap Index returned -2.84% for the third quarter and 20.05% for the year. We continue to recommend overweighting large cap stocks compared to mid and small cap stocks.
New policy changes in China had devastating consequences for Chinese stocks. New restrictions on Chinese education, gaming and internet companies wiped out approximately $2 trillion in market cap. These policy changes were enacted suddenly, catching the market off guard. We have discussed the risk of investing in China in the past. We believe that the power of the Chinese government to enact laws arbitrarily adds a level of risk to most Chinese stocks that would only be acceptable to clients with a high-risk tolerance level. The possible bankruptcy of Evergrande also weighed on the Chinese stock market. Evergrande is one of the largest real estate companies in China and has over $300 billion in outstanding loans. The company has already missed an interest payment to foreign bond investors. The market is expecting some bailout from the Chinese government that will reduce the risk of a financial crisis. The MSCI China index returned -16.79% for the third quarter and has returned -18.13% for the year.
U.S. Large Cap stocks continue to outperform the rest of the world. International equities, as measured by the MSCI EAFE Index returned -.95% for the third quarter and 7.85% for the year. Emerging markets, as measured by the MSCI Emerging Markets Index returned -8.67% for the third quarter and -2.18% for the year. We continue to recommend overweighting U.S. stocks compared to international stocks. For investors interested in investing individual countries we continue to recommend exposure to India, the MSCI India Index has returned 22.18% year to date, over China.
Earnings continue to outpace analysts’ expectations. Analysts had predicted second quarter S&P 500 earnings at $44 a share. Actual earnings were approximately $52 a share – an 18% increase over estimates. Earnings estimates for 2021 were raised from $187 to $198. Analysts are predicting earnings of $218 a share in 2022 – an increase of $8 since the second quarter. Using a P/E ratio of 22 provides a target of 4796 for the S&P 500 Index. This would provide a return of approximately 11% from current levels. This return compares favorably to a ten-year government bond yielding 1.5%. Given our outlook of stocks versus bonds, we recommend clients stay closer to the higher end of their equity allocation, as long as the strategy is also within a client’s risk tolerance.
Investing involves risk, including the possible loss of principal and fluctuation of value. Past performance is no guarantee of future results.
This letter is not intended to be relied upon as forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date noted and may change as subsequent conditions vary. The information and opinions contained in this letter are derived from proprietary and nonproprietary sources deemed by Virtue Asset Management to be reliable. The letter may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projection and forecasts. There is no guarantee that any forecast made will materialize. Reliance upon information in this letter is at the sole discretion of the reader.
Please consult with Virtue Asset Management’s financial advisor to ensure that any contemplated transaction in any securities or investment strategy mentioned in this letter align with your overall investment goals, objectives and tolerance for risk.
Additional information about Virtue Asset Management is available in its current disclosure documents, Form ADV and Form ADV Part 2A Brochure, which are accessible online via the SEC’s investment Adviser Public Disclosure (IAPD) database at www.adviserinfo.sec.gov, using CRD #283438.
Virtue Asset Management is neither an attorney nor an accountant, and no portion of this content should be interpreted as legal, accounting or tax advice.
Investing involves risk, including the possible loss of principal and fluctuation of value. Past performance is no guarantee of future results.
This letter is not intended to be relied upon as forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date noted and may change as subsequent conditions vary. The information and opinions contained in this letter are derived from proprietary and nonproprietary sources deemed by Virtue Asset Management to be reliable. The letter may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projection and forecasts. There is no guarantee that any forecast made will materialize. All information is illustrated gross of investment advisory fees. Reliance upon the information in this letter is at the sole discretion of the reader. Please consult with a Virtue Asset Management financial advisor to ensure that any contemplated transaction in any securities or investment strategy mentioned in this letter align with your overall investment goals, objectives and tolerance for risk. Additional information about Virtue Asset Management is available in its current disclosure documents, Form ADV and Form ADV Part 2A Brochure, which are accessible online via the SEC’s investment Adviser Public Disclosure (IAPD) database at www.adviserinfo.sec.gov, using CRD#283438.
Virtue Asset Management is neither an attorney nor an accountant, and no portion of this content should be interpreted as legal, accounting or tax advice.
Source: Best Financial Advisors in Oak Park | Certified Wealth & Fiduciary Planner | Virtue Asset Management