Vigilare Wealth Management 2021 Q3 Commentary
The third quarter began with the U.S. Federal Reserve (The Fed) hinting at starting to reduce their bond purchase program (QE) in a sign that the worst of the pandemic was behind us. After all, covid daily cases in the U.S. were hitting pandemic lows and the economy was projected to gain 7.8% in the 3rd quarter according to IHS Markit. What followed was a surge in the highly infectious and dominant Delta covid-variant and cases in the U.S. catapulted to 200,000 daily, just a month and a half later. By the end of the quarter IHS Markit had revised their quarterly GDP estimate down to 3.6%. This new variant surge contributed to slowing market momentum which culminated in a sharp September sell-off across the global markets.
Entering the final stretch of the year there are a litany of worries on investors’ minds: Fed tightening, Fed Chairman Powell being replaced, China real estate slowdown contagion, China regulatory crackdown, ongoing pandemic waves, persistent inflation, supply chain bottlenecks, debt ceiling worries, deficit spending, higher taxes, and a peaking of economic activity, etc. All of this has caused investor sentiment to be as bearish as it was during March of 2020, which was in the depths of the pandemic shutdown.
We are watching these developments very closely. A big one is inflation. Inflation has been a concern we have been writing about in the past few commentaries. There has been a surge in prices spanning from real estate, to food and energy, to autos. The big question is are these inflationary pressures temporarily caused by covid related supply chain and logistics problems or is this something more permanent and enduring? Fed Chair Powell during a congressional testimony said that the surge in prices, “is a function of supply side bottlenecks over which we have no control.” Powell’s expectation is that high inflation will abate because it is tied to the pandemic and the reopening of the global economy. There is a growing debate within the Fed on whether raising rates to cool inflation can be effective, while at the same time not having a negative impact on employment growth. If the Fed is forced to act to stave off inflation, we believe there would be bad repercussions for the markets. Fortunately, at this time the Fed is giving the benefit of the doubt to the pandemic driving inflationary pressures and is reluctant to raise rates at least in the near term.
There is much evidence of pandemic driven inflation. For example, the cost of shipping a container from Shanghai to Los Angeles was close to $20,000 at the time of this writing! This is compared to $2,000 prior to the pandemic. There are usually one or two ships waiting at the port in L.A., but currently there are an estimated half a million containers sitting on “fleets” of ships waiting to be offloaded. Prior to the pandemic the global economy had evolved into operating as a well-oiled machine on a just-in-time approach to inventory, shipping, and logistics. The pandemic has stress-tested this paradigm and has led to chronic shortages in shipping containers, factory goods production, chip production, raw materials, passenger airfreight, truck drivers (who wants to drive a truck these days?), warehouse capacity, among other areas. And add to these problems the capricious shopping behaviors of the U.S. consumer during the pandemic. We do agree with the assessment of the Fed that much of this pressure is pandemic related and will normalize in due time (although we recommend doing your holiday shopping sooner than later this year). We are however watching very closely for more persistent inflationary pressures in areas such as housing (affordability and rental) and energy (gasoline and utility prices).
The other obstacle that needs to be cleared is Congressional legislation to address the debt ceiling and the resolution of any further stimulus measures. Clearly, a default on U.S. debt would be bad, however Congress usually gets something done even if it’s at 11:59:59. We will also be pouring through details of any further stimulus packages and the impact that it will have on taxes. An increase in taxes could negatively impact the financial markets depending on the severity.
We are cautiously optimistic heading into the final stretch of the year and even see the potential for a strong rally. If the Delta variant did indeed peak last quarter, then many of these pressures to the economy will subside and we should see an improvement in growth expectations and renewed confidence. Also, with investor sentiment being so negative at this time we believe that any positive surprises will have more of a “positive” impact than negative surprises having a “negative” impact. There are signs that Delta is peaking based on falling cases and delta wave patterns. We are hopeful that the combination of higher vaccination rates and increases in natural immunity (because of prior infections) are enough to keep Covid in check as we enter the fall/winter months. And lastly, Merck’s recent announcement of an effective oral antiviral could be the gamechanger needed in defeating/managing this covid pandemic.
We hope everyone is healthy and safe.
Thank you for your trust.
The Vigilare Wealth Management Team
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