Market Commentary & Portfolio Management Updates

Forth Quarter 2021

Contributors: Andrew Walker, Bruce Ensrud, Matt Stockman 

Click to read as a PDF.


The third quarter saw economic growth cool down a little bit, as the economic reopening began to mature. Inflation driven by supply chain constraints, rising energy prices, and incredibly strong consumer demand led the Federal Reserve to begin reducing asset purchases on its balance sheet. Returns were favorable through the first few weeks of the quarter, but the Federal Reserve’s action caused a sharp reversal in September, leaving US markets roughly flat for the quarter.

Going forward, we expect more of the same. The reopening trade will continue, led by value and small cap stocks – and particularly in developed international markets. The withdrawal of government stimulus around the world should be conducive to value stocks over growth stocks. Waning impacts of COVID-19, combined with strong consumer demand, provide a favorable backdrop for markets to perform well headed into year end.

Where We’ve Been – Q3 Review

Last quarter we hypothesized that strong but fading growth, combined with continued inflationary pressures, could lead to volatility in markets. This is, in-part, how things played out. After starting relatively benign, with both stocks and bonds producing modestly positive returns in both July and August, the third quarter of 2021 finished on a bumpy note when, in September, ongoing inflationary pressures led the Federal Reserve (“Fed”) to announce it would begin tapering assets. More impactful to markets was the Fed hinting at sooner than expected rate hikes. At the end of the day, this was the first monthly decline (as measured by the S&P 500) in 7 months.

This signal that the Fed sent to markets caused rates to rise, which strengthened the dollar (hurting international investments) and weighed on growth stocks and bond investments.

Some below-expectations economic data weighed particularly heavy on small cap stocks, given they can be more sensitive to changes in the “real economy”.

Of course, we did not foresee everything that happened. In addition to the above, other contributors to September’s volatility included concerns around a looming US debt ceiling and developments out of China’s property market that eerily resembled some of the bankruptcies that Wall Street saw in 2008/2009. Not only did this later issue understandably lead to very poor returns for emerging markets, but it also dampened investor sentiment across the globe.

One interesting development to specifically point out from the quarter was a continued decline in the performance of “stay at home” stocks. This is worth monitoring, as it reflects the diminishing impact that COVID-19 is having (or is expected to have) on the economy.

Where We’re Going – 2021 Q4 Outlook

While the third quarter saw some volatility in markets, our view on the economy remains largely unchanged. We expect solid but fading growth as the reopening matures and global stimulus is pulled from the system. There will continue to be inflationary pressures thanks to demand outstripping supply (pent up demand, excess stimulus in economy, supply chain issues), rising energy costs (geopolitical issues, aggressive anti-fossil fuel regulations), and a shortage of labor (wage inflation). Although we do not anticipate inflation to get out of hand – especially with the Federal Reserve set to raise interest rates – many of the aforementioned sources of inflationary pressures could take time to fade away, so we will continue to let this view inform how we manage portfolios.

Looking to the end of the year, we believe that markets will finish on a strong note thanks to a continued fading of COVID-19’s impact on the US economy, robust corporate earnings, and impressive demand from an American consumer with record levels of savings.

What could cause markets to finish the year on a bumpy note? This is nearly impossible to predict. As Elroy Dimson of the London Business School defines it, risk simply means “more things can happen than will happen”. That said, some things that could destabilize markets, should they materialize, would be a US government shut down, unexpected action by the Federal Reserve, geopolitical tensions with China, or a COVID-variant that warrants economic shutdowns. We see these risks as small, given deeply engrained incentives of both the US and Chinese governments to stabilize their economies and continued improvements in vaccination rates.

Portfolio Management Updates

While the past few quarterly commentaries each introduced new portfolio positions, there is no such introduction to be made here. In fact, such updates are unlikely to occur every quarter. Only when our view on markets has changed materially will we make adjustments to portfolios.  It is worth noting, however, that we are very pleased with the performance of the positions we introduced in the past few commentaries. We believe that some of these will be core components of our portfolios for many years to come, while others will continue to serve their short-term purpose of helping us implement some shorter-term market views.

Taking a step back, our portfolios remain tilted in favor of the reopening trade and rising inflation. In equities, our “reopening trade” positioning still has us overweight cyclically sensitive areas of the market, including small-caps, value, and international developed stocks. In bonds, we remain disenchanted with the unattractive risk/return opportunity set that the low level of interest rates presents. Given this, and our views on inflation, we remain focused on shorter-term bonds, inflation protected securities, and non-bond diversification sources.

While no changes were made to portfolios this quarter, we do continue to pull on an array of levers to add value to our clients.

One of these levers is related to rebalancing. Because markets ended the third quarter relatively flat, portfolio allocations did not warrant rebalancing, as they were well within their desired ranges. We continue to risk manage portfolios on an ongoing basis and will rebalance if and when doing so becomes prudent.

Another one of these levers is related to tax optimization. With year-end approaching, we have been meticulously scouring client portfolios for opportunities to save on taxes. Specifically, we have been preparing for annual mutual fund capital gains distributions, as well as identifying opportunities to offset capital gains with tax loss harvesting. Because 2021 has thus far blessed us with very favorable market returns, we expect 2021 portfolio-related tax liabilities to be higher than usual.

Thank you for allowing us to partner with you as we navigate the ever-changing market. We appreciate your continued trust.

If you have questions or would like to dive deeper into this quarter’s outlook, please reach out to our investment team. We’d be happy to set up a virtual coffee to talk more.

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