| 3rd Qtr.
| 12 Mo.
|10-yr Treas. yield
|Fed funds rate
|0 – 0.25%
|0 – 0.25%
|0 – 0.25%
(stock indices are before dividends; yield and rate changes are absolute changes)
A September slide took the shine off a strong start to the quarter, with stocks posting their worst month since last September. Just when it looked like the markets may recover, the last four days of the quarter were particularly bad. The S&P 500 managed to eke out a positive quarter, reflecting investor moves out of growth and interest-rate sensitive stocks. The US dollar hit its highest level in a year against the basket of six major currencies, while the benchmark 10-year Treasury dropped through July to a low of 1.18% before rising steadily through September.
The combination of the Delta COVID variant, the uncertainty surrounding the debt ceiling, and lingering inflation concerns (not to mention that it’s been a long time since a market correction) all contributed to the September pause. The Fed conceded that inflation has hung around longer than originally anticipated but still insists that the supply constraints will moderate. The Fed expressed optimism that the COVID recovery will continue but the biggest change was the signal that the buying of bonds by the Fed could start to wind down by year-end. The last time this happened in 2013, the market drove interest rates sharply higher in what is known as the “taper tantrum”. There could be 6 or 7 rate hikes by year-end 2024, although it is split on whether those hikes will begin in 2022, and year-end 2021 unemployment forecast was raised to 4.8%.
The Chinese government, which has become increasingly involved in directing economic activities, announced a ban on all cryptocurrency-related activity. This ban includes all crypto “mining”, which uses massive amounts of energy, and all transactions, which are a bit too decentralized and uncontrolled for the government’s liking. At the same time, Evergrande, the second-largest Chinese real estate developer, is collapsing under debt of over $300 billion, which is 2% of China’s GDP and bigger than the GDP of New Zealand or Finland. How the crypto ban will affect that market, or whether the Evergrande struggles will spread to other debt-laden Chinese companies, is yet to be seen.
Despite the uncertainty, consumer confidence at a 7-month low by some measures and a higher indicator that jobs are considered harder to find, consumers kept spending at a 1.2% increase for the last three months. Durable goods orders were up for 15 of the last 16 months, and core capital goods (a proxy for business investment) were also positive. Housing inventory is still shrinking but the rate of decline is slowing and with the end of the mortgage forbearance program more homes may come on the market. There are signs that bidding wars are easing but price increases continue to set records, from 14% to 18% for the last 12 months. August job gains were well below expectations and the labor participation rate is stalled but manufacturing jobs grew, average earnings were up 4.3% over last year and the unemployment rate fell slightly to 5.2%.
It all adds up to some lower growth forecasts from the OECD both in the US (2021 at 6% from 6.9%) and globally (5.7% from 5.8%), although the eurozone was improved and China was flat. Economic recovery forecasts were shifted a bit into 2022, with both the US and global forecasts slightly higher, and US inflation is still expected to moderate from its current forecast of 4.2% for 2021.
Having averted a government shutdown with a short-term spending measure, Congress must now get its act together and address the debt limit before the estimated “drop-dead” date of October 18. That’s when the Treasury will effectively be out of money and the US government will be in default, an unimaginable event with huge (Treasury Secretary Yellen used the term “catastrophic”) consequences.
What is most frustrating about the debt ceiling is that the increase is needed to meet current obligations in addition to funding ongoing government shortfalls. And regardless of your politics, both sides are making things more complicated by tying spending and the debt limit to other priorities. As the saying goes, if you are on a sinking ship, just get to shore and deal with the other stuff later.
Longer term, of course, are the two stalled major spending measures, the $1 trillion infrastructure package (with a broad definition of infrastructure) and the $3.5 trillion measure that covers a massive increase in government programs and spending. Equally as contentious will be how to pay for whatever package is finally enacted, although it is a near certainty that taxes will increase on incomes over $1 million and changes to estates taxes and rules will be made before 2025 when some changes are already set to take place. Where tax changes will go beyond that is anybody’s guess, with liberals suggesting that taxing the “rich” will be sufficient and conservatives contending that tax increases will quickly drift lower from the $1 million level.
Still, we have seen similar government binds before and have gotten through them, if not unscathed at least undeterred. Of course, the political environment has seldom been so polarized, or at least we are reminded every day. The combination of these measures could indeed have an impact on the markets and economy but the other economic factors we are wrestling with will probably be the main drivers going forward.
We have often emphasized that we follow a long-term strategic allocation in our portfolios and take what the markets give us, integrating those market returns with comprehensive financial plans and clients’ goals and objectives. This is not necessarily revolutionary, but most investors find it a very difficult path to stay on; the temptations of short-term strategies are just too great. You’d think institutions, with all their professional resources and advice, would be different. Sadly, that’s not the case.
Jason Zweig of the Wall Street Journal profiled a good example, the Pennsylvania Public School Employees’ Retirement System ((PSERS), which holds $66 billion in assets. We have been living with low interest rates for so long it should be seen as almost normal, but PSERS is still sticking to projections of higher returns. It has moved aggressively into hedge funds and private equity and uses around 170 external money managers. Most public pension plans use around 55 firms to manage their money. The results have been underwhelming – PSERS’ 10-year performance ranked 94th out of 133 peers.
And PSERS is not alone. Richard Ennis, a consultant to pension funds since the 1970’s, estimates that underperformance at public retirement plans, mostly from paying high-riced asset managers, is nearly $70 billion annually. At the same time, most pension systems have not adjusted their return assumptions. In 2009, when the 10-year Treasury yield was almost 4%, 8% was the average annual return assumption. Today, with the Treasury yield around 1.5%, that assumption has fallen to only 7%. If those returns do not materialize, it will be taxpayers who are on the hook for the shortfall.
The choices are pretty straightforward – take additional risk in traditional areas like stocks, add new and exotic bets, grit your teeth and wait until interest rates go back up, or (the most difficult one) adjust your expectations and increase funding now to make up the future shortfall.
The well-known “serenity prayer” asks for “serenity to accept the things I cannot change, courage to change the things I can, and wisdom to know the difference.” In contrast, the precocious and mischievous Calvin in the classic comic strip Calvin and Hobbes prays for “the strength to change what I can, the inability to accept what I can’t, and the incapacity to tell the difference.” Hobbes says Calvin should live an interesting life, to which Calvin proudly responds “oh, I already DO!” Serene or interesting – investors face a similar choice.
Help Wanted by JD Matchett-Robles
From your local restaurant to the hardware store, you can’t go anywhere right now without seeing help wanted signs. There are constant stories of restaurants shutting down or reducing hours because there simply is not enough staff to cover shifts. This is not a localized problem, but it is widespread and impacts every size business and is something we can all feel in our everyday lives as services and products are unavailable or delayed. Although some delays and shutdowns are supply-chain related, there is undeniably a labor crisis at hand. Unemployment in the U.S. at the beginning of the pandemic reached as high as 14.7% in April 2020. According to the Labor Department, 20.5 million people lost their jobs due to the pandemic (the unemployment numbers were and are much worse for certain demographics, including minorities and women). However, despite the stubbornness of the pandemic and its lingering effects, the market and the economy have found a way back to prepandemic levels and beyond.
The unemployment rate dropped to 5.2% in August 2021, the lowest level since the start of the pandemic. The number of unemployed stands at 8.4 million. That is an incredible improvement from last April, yet that is still far above the pre-crisis level of 3.5% or 5.7 million unemployed. Looking at this from a high level, it begs the question why are so many people still unemployed and yet so many job openings left unfulfilled? What is causing this dual reality between the millions of unemployed and the countless job openings? The answer, of course, is complicated.
The simplest response is to blame the lack of work seekers on the enhanced unemployment benefits and stimulus checks. This article is not trying to be a proponent for or against the policy, but no one can deny that millions were in need (7.9 million still unemployed in March 2021), nor can it be denied that there were some individuals that ended up with more cash in hand with these checks than they would otherwise make at an hourly job. However, blaming the employment crises as merely the result of increased unemployment benefits is oversimplifying the problem. The increased benefits ended on September 6 (Labor Day, ironically), so we still need some time to give us more clarity as to the role these payments made. Let’s explore some of the other potential factors.
Some people have simply been afraid to return to work due to ongoing COVID concerns. In particular, the service industry has been hit hard with the labor shortage. Many potential workers have voiced concerns about workplace safety as they deal directly and in close contact with people throughout their workday. These individuals have decided the risk of COVID exposure is not worth the pay they receive in return. Others have seen this as an opportunity to make a career change. Whether it is opportunities to work remotely, better pay, more flexible hours, or other reasons, there are large amounts of the workforce that do not plan to return to their old job.
Finally, there are geographic reasons for some labor shortage issues. As remote work replaced the traditional office workspace, many workers moved to new locations, some permanently. Suddenly there was an influx of new residents (or previous commuters that are now working from home) that were around seven days a week in suburbs, small towns, and remote areas, creating more demand at local restaurants, stores, and other services. The problem is the people that would fill those new jobs are not in those areas but still based in cities and business centers where the work used to be. Simply relocating is not an option when you consider moving costs and the higher cost of living in many of these locations. Even beyond services, jobs in various industries remain unfulfilled as people with particular skills do not live where those jobs are offered.
The cause of the labor shortage is likely some combination of the above reasons, plus many more, but it is important to realize the problem is complex, as is the solution. One restaurant in New York recently offered to pay employees $25 per hour and quickly filled the vacant positions. To offset costs, menu prices increased, and the menu was streamlined. Maybe increased pay is the simple solution, but of course with that will come increased prices. In the end, the real solution may be adjusted expectations for consumers. Whether it’s increased costs for that hamburger or longer wait times at the checkout, we likely have to adjust our expectations and bring a little patience wherever we go, at least for the time being. Hopefully, some good will come of the current job crises, perhaps higher pay, more opportunities, and better quality of life. The supply chain will be fixed, and jobs will get filled, but for now get used to seeing those Help Wanted signs.