Equity markets declined this week, bringing a close to the worst month for the S&P 500 since March 2020. Markets continue to struggle with two insidious foes in their attempts to get back on track from lockdowns: inflation and supply chain constraints. The Fed has largely argued that resolving the latter of those issues will resolve the former, but the situation has proved to be much more challenging than the Fed originally proposed. Supply chains are struggling with material costs and transportation issues in addition to basic production limitations, many products have been unable to be produced due to a disruption upstream in the supply chain process, creating even further reduced capacity utilization for finished consumer products. Supply is struggling mightily to get back in line with demand. Lesser issues but still relevant to the economic picture are high COVID infections and labor shortages; as time passes both of these issues should subside. Overall, markets have performed well YTD, but headwinds are now beginning to fiercely resist further progress.
Overseas, developed markets underperformed emerging markets, with both indices returning negative performance. European indices were negative, while Japanese markets also returned negative performance for the week. Improving prospects against the pandemic as well as improved prospects for economic recovery should continue to help lift markets globally over time, but macroeconomic factors such as inflation and supply shortages threaten markets everywhere.
Equity markets were negative this week as investors continue to assess the state of the global economy. While fears concerning global stability and health overall appear to be in decline, the recent volatility serves as a great reminder of why it is so important to remain committed to a long-term plan and maintain a well-diversified portfolio. When stocks were struggling to gain traction last month, other asset classes such as gold, REITs, and US Treasury bonds proved to be more stable. Flashy news headlines can make it tempting to make knee-jerk decisions, but sticking to a strategy and maintaining a portfolio consistent with your goals and risk tolerance can lead to smoother returns and a better probability for long-term success.
Chart of the Week
Sector performance has largely converged in Q3, with performance spread between the best and worst performing sectors coming to only about 6%. This is the smallest spread posted by markets in over 20 years.
Broad market equity indices finished the week negative, with major large cap indices underperforming small cap. Economic data has been mostly encouraging, but the global recovery has a long way to go to recover from COVID-19 lockdowns.
S&P sectors were mostly negative this week. Energy and financials outperformed, returning 5.79% and -0.30% respectively. Technology and healthcare underperformed, posting -3.34% and -3.54% respectively. Energy has the lead in 2021 with a 42.92% return.
Oil rose this week even as crude oil inventories unexpectedly rose. Energy markets have been highly volatile in the COVID era, but it appears that higher oil prices may be more of the norm given recent market fundamentals. Demand is still low compared to early 2020, but as global economies are continuing to improve, oil consumption is recovering rapidly. On the supply side, operating oil rigs are still well under early 2020 numbers, but trending upwards. In addition to supply and demand, a volatile dollar is likely to have a large impact on commodity prices. A new dimension has emerged recently in energy markets, as China has been unable to acquire the energy needed to keep its power grid running without interruption, and Europe and other regions have not been able to acquire enough natural gas to meet anticipated heating needs for winter. Many analysts are anticipating natural gas prices to rise substantially as countries desperately try to fill shortfalls before the weather turns too cold, and that manufacturing operations in China could remain under strain for some time.
Gold was little changed this week as the U.S. dollar strengthened slightly. Gold is a common “safe haven” asset, typically rising during times of market stress. Focus for gold has shifted again to include not just global macroeconomics surrounding COVID-19 damage and recovery efforts, but also inflation and its possible impact on U.S. dollar value.
Yields on 10-year Treasuries rose this week from 1.4509 to 1.4616 while traditional bond indices fell. Treasury yield movements reflect general risk outlook, and tend to track overall investor sentiment. Expected increases in future inflation risk have helped elevate yields since pandemic era lows in rates. Treasury yields will continue to be a focus as analysts watch for signs of changing market conditions.
High-yield bonds fell this week as spreads loosened. High-yield bonds are likely to remain more stable in the short term as the Fed has adopted a remarkably accommodative monetary stance and major economic risk factors subside, likely helping stabilize volatility. A headwind could be on the horizon, as the Fed has expressed that asset tapering will likely take place in November 2021, which could raise yields.
Lesson to be Learned
Don’t look for the needle in the haystack. Just buy the haystack.”
FormulaFolios has two simple indicators we share that help you see how the economy is doing (we call this the Recession Probability Index, or RPI), as well as if the US Stock Market is strong (bull) or weak (bear).
In a nutshell, we want the RPI to be low on a scale of 1 to 100. For the US Equity Bull/Bear indicator, we want it to read at least 66.67% bullish. When those two things occur, our research shows market performance is typically stronger, with less volatility.
The Recession Probability Index (RPI) has a current reading of 28.88, forecasting a lower potential for an economic contraction (warning of recession risk). The Bull/Bear indicator is currently 100% bullish, meaning the indicator shows there is a slightly higher than average likelihood of stock market increases in the near term (within the next 18 months).
It can be easy to become distracted from our long-term goals and chase returns when markets are volatile and uncertain. It is because of the allure of these distractions that having a plan and remaining disciplined is mission critical for long term success. Focusing on the long-run can help minimize the negative impact emotions can have on your portfolio and increase your chances for success over time.
The Week Ahead
This week sees a couple heavy hitters in the economic data department, with both nonfarm payrolls and services PMI numbers being released.
More to come soon. Stay tuned.