Commentary on the Market: Third Quarter 2021

On the first day of October, we formally put the third calendar quarter of 2021 behind us.  It could not come fast enough to put September, which is ordinarily the most volatile market month of the year, behind us. Although October does experience some volatility, it proves to be a pivotal month as a transition to the strongest quarter of the year.  The last quarter of the year is often referred to as “The Santa Claus Rally,” where consumers cheer up and do an exaggerated amount of spending in anticipation of the holidays. This is the quarter where retailers derive over 50% of their annual revenues.  With consumer sentiment rising, this is also a great time for the financial markets.  Data, provided by the research company Bespoke, indicates that the Dow has rallied an average of 4.5% in the fourth quarter over the past 20 years.  That compares to the average rise of 1.2% in each of the preceding quarters.  Last year the Dow rose an astounding 10.2% in the fourth quarter.  The S&P’s performance has proven quite good as well.  It has posted an average gain of 3.95% in the fourth quarter since 1950.  However, in 2020, it surged 11% for the same period.

Even though expectations are that the fourth quarter will reap positive returns, let’s cover the areas that could hold things back. There are certainly concerns over COVID-19’s impact on the global economies. Vaccination rates are increasing in many developed countries with illness and death rates slowing down.  However, the fear is in poorer developing nations that have not had the benefit of mass vaccination is that a new variant might appear and extend the pandemic.  Many of these less fortunate countries play an integral role in the global economy.  They manufacture and ship goods to developed countries that rely on adequate supply and timely delivery.

Another issue that is not resolved, and will not resolve itself overnight, is the that of a scarce labor force within the U.S. economy.  More than a year and a half into the pandemic, the U.S. is still missing close to 4.3 million workers.  If all workers 16 and above returned to work, we would be at February 2020 employment levels.  U.S. employers are currently struggling to fill more than 10 million job openings and meet current consumer demand.  Some economists are concerned that these worsening worker shortages reflect longer-term shifts, such as the pandemic-driven early retirement by many, which will not reverse.  This in addition to losses of more women dropping from the work force, workers without college degrees not returning and many from the low-paying industries such as the hospitality industry are adding to the problem.  I noted in my last newsletter that we are still experiencing an economy driven in part by stimulus money that has been saved by many, which is fueling a high rate of spending by consumers.  There will eventually be a transition to an earned income economy where consumer spending will more so be driven by wages that they earn.  This should be a truer representation of the strength of the U.S. economy.

There is another lingering fear regarding the economy.  The fear that inflation will continue to rise, diminishing purchasing power.  Many believe that this inflation is being driven by rising energy and commodity prices.  The opposite is closer to the truth. The current pickup in inflation is being driven by the restart of the economy and government stimulus, not from rising oil and commodity pricing.  The rise in prices of consumable products more accurately is being driven by an excess supply of money which has been sitting on the sideline through much of the pandemic.  Now, consumers are opening their wallet to buy and finding that there are shortages of desired products. The race to buy existing inventory is driving prices up.  It is anticipated that the restart will run well into 2022, which was originally the expectation of the Federal Reserve Bank.  The Feds governors felt that inflation would moderate after a short period of time after the economy restarted.  However, inflation has gotten ahead of their own expectations. They recently stated that they will refrain from providing further stimulus to the economy.  This should allow them more flexibility to manage interest rates which should keep inflation at a manageable level as we transition to an earned income economy.

Despite the road blocks that I have highlighted, the rise in spending has created a significant demand for goods and services. This has led to further interest and anticipation of how robust corporate earnings for the third quarter would turn out. The large U.S. banks are generally the first to announce their earnings and their success is a great indicator of the economy and furthermore the direction of the financial markets.  Analysts were expecting major bank earnings to exceed the prior year by roughly 17%.  The major banks, which reported the second week in October, did not disappoint.  They surpassed even the analysts’ expectations.  Additionally, by the third week of October, over 80% of those companies that have reported so far have exceeded analysts’ expectations.  This positive news is telling us that many of the fears that keep widely circulating are not an indicator of doom for the markets, but more so an indicator that demand for goods and services is rising and that there is a shortage of supply.  Manufacturers are working overtime to provide supply while at the same time looking to fill open positions.

The economy will transition over time from stimulus-based consumer demand to earned income driving economic growth.  The expectations of many more Americans returning to work and spending money on goods and services bodes well for the financial markets. I anticipate continued economic growth in 2022 and perhaps through much of 2023.  The economic expansion will continue resulting in continued growth from the financial markets.  Although interest rates will eventually rise modestly, they will not provide enough return vs. inflation to make bonds or cash investments a profitable alternative for now.  Stocks have significantly outpaced bond and cash investments historically.  The stock markets will, as they always have been, play a very significant role in the future of most investors.  A well balanced portfolio can provide for a prosperous future.
I wish you all well and remain available to address any thoughts or questions that you may have.  915-760-5551

Ruben E. Guerra