Buy the Dip
The equity markets soared in October bouncing back from a long overdue 5+% pullback experienced in September. There were several drivers that brought investors back into equities including, ebbing Delta-variant cases and hospitalizations, a dovish Fed, better than expected economic data and strong corporate earnings reports. Underlying these reasons is the persistence of negative real interest rates, which provides the foundation for risk assets, like equities, to rise and the economy to grow. This fodder fueled a rally that found the equity markets making new record highs by month end.
The most exciting news in our view during the month was from the pharmaceutical company, Merck. Merck and its partner Ridgeback announced that their antiviral therapeutic, Molnupiravir, reduced hospitalizations and deaths from Covid by 50%. Importantly, this therapeutic comes in pill form making it easy for recently infected individuals to take at home. To us, this is an ideal solution as concerns regarding the effectiveness of the vaccines mount. This advent could spell the end of the Pandemic and the beginning of localized endemics.
Market Update
The U.S markets rebounded strongly in October. The S&P 500 finished up 7.0% for the month, as the Nasdaq and the Dow rose 7.3% and 5.9%, respectively. This performance occurred even as the US 10 Year Treasury bond (“UST10”) yield continued its upward march from 1.49% to 1.55% and at one point reaching 1.70% nearly matching the YTD high set back in March. As we mentioned last month, the pullback experienced in September could be largely explained by the market coming to terms with the Fed tapering their asset purchases – a sign of monetary policy tightening. In October, market sentiment flipped buoyed by strong economic data even while pricing in higher inflation expectations into the yield curve.
Fixed income indices were largely flat. The Bloomberg Barclays U.S. Aggregate Bond Index and Investment Grade Bond Index were literally flat. The riskier U.S. High Yield Bond Index finished down slightly. We continue to view fixed income as a poor risk reward trade-off given the likelihood of higher interest rates, which forces bond prices down, and the extremely tight spreads in high yield and other riskier bonds. Given how little yield exists, there is simply not enough upside to offset these risks.
Commodities were broadly stronger again as investors sought shelter from higher inflation expectations. The Bloomberg Commodities Index rose 2.6% during October. Leading the way once again was oil, which increased 10.6%. West Texas Intermediate finished the month at $83.57 per barrel – a price not seen since 2014. Meanwhile, natural gas experienced significant volatility and ended October down -5.1% but not before surging above $6 per mmBtu. Last month we pointed out the oddity of gold and silver – normally good inflation hedges – underperforming in spite of current inflation concerns. In October, silver broke out its slump gaining 7.7% with gold still lagging up only 1.5%.
Deceleration At Last (Sort of)
Avid readers know that we have been forecasting a deceleration in the U.S. economy from the overstimulated levels experienced through much of the last year. The first evidence came in the first GDP estimate released for the September ended quarter. Q3 GDP growth came in much lower than the market expected at 2.0%, which is down considerably from Q2’s 6.7% growth.
So, what caused this precipitous decline in GDP growth? It was not due to a lack of consumption as we can see from the chart below. Personal consumption expenditures continued to set record highs through the quarter. The cause was supply chain bottlenecks and, specifically, those affecting the auto industry. The lack of parts and semiconductor chips has dramatically impacted new vehicle production. According to Ward’s Automotive Group, U.S. Light Vehicle sales in Q3 declined -21% from Q2. Taking all of these supply chain woes into account, GDP was dragged down -2.8%. If we add back this temporary phenomenon, the economy really grew at a 4.8% pace, which is still very strong by any historical measure.
Disclosures
INFORMATION PRESENTED IS FOR EDUCATIONAL PURPOSES ONLY AND DOES NOT INTEND TO MAKE AN OFFER OR SOLICITATION FOR THE SALE OR PURCHASE OF ANY SPECIFIC SECURITIES, INVESTMENTS OR INVESTMENT STRATEGIES. BLOOMBERG IS THE SOURCE OF MARKET DATA. INVESTMENTS INVOLVE RISK AND ARE NOT GUARANTEED. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RETURNS. BE SURE TO FIRST CONSULT WITH A QUALIFIED FINANCIAL ADVISER AND/OR TAX PROFESSIONAL BEFORE IMPLEMENTING ANY STRATEGY DISCUSSED HEREIN.