Negative news and worrisome trends unsettled global stock markets in September. The Delta variant of the Coronavirus continued to spread, overflowing hospitals in areas with low vaccination rates. Supply chain woes and labor shortages constrained growth by forcing companies in manufacturing and services to operate below capacity. Global energy prices spiked, catching many off-guard. Evergrande, China’s second-largest property developer, wobbled under crushing debt. Meanwhile, word that the Federal Reserve may start to unwind its support of the economy in coming months weighed on investors. Bond yields rose. Inflation persisted and stagflation entered the discussion. Equity markets sank.
For all the worries that infected September markets, one thorny issue rose to the top. Inflation does not appear to be subsiding as quickly as forecasters had anticipated, leaving investors concerned that the chief tool for attacking it—higher interest rates—could torpedo the financial stability and economic recovery that Central Banks have so carefully nurtured over the past year and a half.
The sense that options for a soft landing are dwindling may have precipitated the sharp 4.8% drop of the S&P 500 in September. Substantial swings in day-to-day prices reflected investor uncertainty. It was the first monthly decline since January and the steepest plunge since March 2020, when Covid-19 shut down the global economy. Even so, through September the S&P 500 was 27 percent higher than its pre-pandemic record. Year-to-date the index returned a generous 16 percent, a strong nine-month performance by any measure.
Since the beginning of the year, many people hoping to see dramatic improvements in the quality of their lives have had to ratchet down expectations, even as stock markets soared. We expected Covid-19 to be under control after the record-setting speed with which vaccines were developed. We expected Americans to return to work in droves. We expected schools and daycare to be functioning normally. We expected a smooth flow of goods and services through the economic pipeline. Our hopes outpaced reality. And reality threw us a few unexpected curveballs, like low-wage workers holding out for better jobs and women leaving the workforce in large numbers.
As we enter the fall season, bearish predictions of impending economic disaster are on the rise, even as positive trends are gaining traction. The Covid-19 Delta variant is receding as the federal government, some state governments, and private employers have begun to enforce vaccine requirements for returning workers. The wall of vaccine resistance is “a lot less solid than it may have seemed” reports Paul Krugman, with just one to two percent of workers refusing new mandates to get jabbed (New York Times, 8-October). Supply chain issues should also resolve, he believes, as Covid-related shutdowns become less commonplace and pandemic-fueled demand for goods subsides. Krugman believes that we will all be feeling better about life by early next year. We hope he’s right.
Do high asset prices signal a fall?
Despite the havoc created by Covid-19 over the past year, stock markets have soared, bond prices are at record levels, and real estate valuations have skyrocketed. “The prices of … the three major asset classes in the United States are all extremely high. In fact, the three have never been this overpriced simultaneously in modern history,” Robert Schiller observes (New York Times, 3-October).
There are many explanations for skyrocketing prices, Schiller points out, and anyone paying attention to the financial news has certainly heard some of them. It’s easy to point to the Federal Reserve, he says, which for years set the federal funds rate near zero and engaged in innovative policies to push down the yield on long-term debt. While there is an element of truth to this model, it is oversimplified, Schiller argues. “What we are experiencing isn’t caused by any single objective factor. It may be best explained as a result of a confluence of popular narratives that have together led to higher prices.” Hence, a major decline in asset prices, when and if it comes, “is unlikely to be a simple reaction to the Fed, which has, for the most part, behaved predictably.”
With prices so high, some investors may feel nervous or cautious. We believe it’s better to remain level-headed and thoughtful. Stay diversified, with an eye on your personal risk tolerance, investment objectives and time horizon. This is prudent guidance, regardless of whether stocks are sinking or rising swiftly.
For access to a Q3 2021 market summary, courtesy of DFA, please click here.
If you would like us to review your asset allocation or if have other portfolio questions, please contact us. We are here to help.
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