Tom Stringfellow, CFA®, CPA®, CFP®
Chief Investment Strategist
Unchartered Waters
On the cusp of change
Investors today are facing a wave of economic uncertainties. Over the past 18 months, central banks have provided the backstop for liquidity and investor confidence. That confidence, in turn, has propelled the markets to unparalleled highs from the short-lived recessionary plunge last year. The staggered economic reversals have likewise reopened COVID shuttered businesses while spurring consumers to spend beyond post-pandemic shopping growth rates. At the same time, this push by investors, consumers and companies to get back on track has led the markets to today’s economic point where supply chain shortages now compound future inflationary worries.
Assuming inflation fears are warranted, the follow-up question is: To what extent will the markets be impacted once the Fed begins its preannounced winding down in incremental asset purchases of $15 billion ($10 billion in Treasury bonds and $5 billion in mortgage-backed securities)? These tapering efforts, which are expected to be followed next year by rate increases, are also concerning to investors who fear an unsettled market impact from the initial reversal in an unprecedented global monetary stimulus regime.
Reasons to be concerned certainly exist with the planned deleveraging of the current Fed balance sheet holdings. On February 17th last year, as the pandemic crisis was beginning to unfold, booked assets on the balance sheet totaled $4.17 trillion. Today that figure has grown to $8.67 trillion, a result of the central bank’s efforts to support the financial markets through asset purchases. These open market operations not only provided needed market liquidity but also helped bolster investor confidence. Concerns today center on whether or not that confidence unravels with the tapering/ shutdown in liquidity support. Fortunately, the Federal Reserve has been straightforward with investors, and it has communicated upcoming policy changes well.
Another significant worry has been whether or not the current Fed president would be reappointed—an issue just addressed by President Biden’s reappointment of Jerome Powell to this lead role. Three other appointments within the FOMC and Board of Governors to replace retiring members remain to be made, but the financial markets can take comfort in the leadership experience continuing at the helm of the Federal Reserve and continuing efforts to manage future rate hikes, while managing the stated goals of both full employment and economic growth.
Gauging consumers’ mood
At the same time, consumer confidence levels have been sliding lately. The University of Michigan’s November reading fell to an index level of 66.8, a drop of five points over a month’s period. There was sufficient blame to go around for the drop in confidence levels with concerns over rising gas, food and housing prices. Several survey respondents also expected lower living standards next year as a result of inflation. Of interest, however, while the one-year ahead inflation expectations rose to 4.9%, many of those surveyed expected longer term inflation closer to 2.9%.
In contrast to the souring outlook reported in the University of Michigan survey, positive news still offsets the consumers’ current perspective. The labor markets are certainly mixed, but jobs exist for individuals who are looking. Consider, as one example, October’s data reporting nonfarm payrolls which are up by 531,000, coupled with a positive revision of 235,000 over the previous two months.
Growth metrics were also positive across several sectors as manufacturing payrolls reported the highest jump since the initial re-opening of the economy last year, while the service industry brought on new staff at the highest pace in three months. Add a jump in hourly wages (up 5.8%) and still near-record job openings (+10 million), and there are jobs available.
Consumers also left their pessimism at home last month with another banner report for retail sales. There were certainly outliers, but the month/month report for total retail sales growth was up 1.7%. Looking at the longer term, retail sales were up 16.3% versus this time last year, the eighth straight month of double-digit sales growth versus the respective previous year’s time frame. From a COVID-19 low in April 2020, retail sales are up more than 55%, and from the prior peak in January last year, sales are up more than 21%. The highest sales growth on a year-to-date basis, not surprisingly, was bars and restaurants, up 41%.
The business backdrop and supply chain issues
The past month has delivered a mixed bag of news from a business and manufacturing perspective, much of it unfortunately tied to the supply chain backup. One reading from the ISM Manufacturing Index was rather telling as it dipped to 60.8 last month, down from the prior month’s reading of 61.1. Interpreting the noise, the survey tells us that while the index is still at a strong level (+60), a drag exists on manufacturing related to shortages.
Even so, we’ve noted a slight reprieve with a rebound in October’s industrial production report, given a 1.2% month/month recovery which includes a 1.6% increase in factory output. Certainly, there was a degree of relief from the rebound of earlier hurricane disruptions, but I am also not discounting the 11% uptick in auto production along with the news out of GM and Toyota of an expected ramp-up in production through the balance of the year.
The outlier issue though is still the shortage in computer chips because of the surge in demand and pandemic-related manufacturer closures. Manufacturers take time to re-open and get back online, causing shortages and price increases in the meantime. Shortages and delays have broadened out since the economic rebound, however, with delays leading to longer manufacturing lead times and inventory shortfalls. A third-quarter Deloitte CFO Signals Survey highlighted these costs, time delays and corporate profit impacts. The survey noted that 44% of CFOs said supply chain shortages would increase their companies’ costs by 5% or more, 32% reported their 2021 sales have already fallen, and 28% expect future sales to suffer this year.
There was also positive news, however. November’s ISM Services Index booked a record high of 66.7, up five points from the prior month. The report noted that it was the fourth time this year that the services sector grew at a record pace against the backdrop of strong demand. The index included comments that expanded on the numbers a bit more which noted ongoing challenges including supply chain disruptions and labor shortages—signs signaling a healthy consumer demand stymied by a rebooting manufacturing and delivery network.
Inflation versus expectations
Prices have risen across several categories as a result of consumer spending growth returning to pre-COVID trends. Meanwhile, distribution channels have struggled to reboot while manufacturers are still having issues recruiting labor. Inventory improvements—at least for some large retail chains—have occurred but not enough to dampen headline price increases across gas stations, car lots or grocery checkout lines. The unknowns are whether or not inflationary pressures resolve once supply disruptions are back to normal and whether price increases are sticky or will fade when competition gets back online.
As far as expectations, consumers and businesses are feeling the brunt of the rising costs and depleted shelves. Those issues are reflected in near-term inflation expectations and in the recent headline inflation rate of 6.2% which factors in a basket of goods along with groceries and fuel. October is now the sixth straight month with a headline inflation reading above 5%, and it is gaining attention. One data point of interest from Bespoke Investment Group observed that the last time this stretch of 5%-plus inflation occurred was in January 1991. In that case, the 5% inflation range leveled off after the seventh month followed by positive S&P returns over the following year. Meanwhile, it is interesting to note that five-year forward return expectations are still holding in the 2% range. Time will tell.
Year-end market countdown
The holidays are around the corner as are the holiday shopping day countdowns. Black Friday started a bit earlier, setting the stage for what will undoubtedly be a really interesting retail season. Investors will be watching online sales, foot traffic, TSA travel statistics, and sales margins and reports. While the markets have already experienced rate-risk volatility, what will be telling is how investors gauge the last-minute sales rush and retail inventory management. As you will no doubt recall, last year’s holiday retail sales mood was definitely colored by the pandemic. Although COVID is still in the news and everyday conversations, it has become more of a background story. Investors are more interested in looking forward to see how companies will get back to full operating capacity.
S&P 500 index returns through October were up 22.6%, the strongest 10-month performances since October 2013. And according to Bespoke Investment Group, 2021 is only the 10th year since 1928 with returns this strong. Historically, this environment sets the stage for the balance of the year. Unfortunately, investors are getting a bit nervous about supply chain issues and inflation fears. The returns through November 19 are still impressive with the broad benchmarks posting 20%-plus returns. All sectors are double-digit performers with the exception of utilities and consumer staples.
This impressive performance has not been the case for the bond markets with year-to-date returns that are all negative, except for the inflation-protected TIPS markets (up 5.81%). Overseas, not all markets have been equal with emerging markets and the BRIC countries (Brazil, Russia, India and China) posting negative returns through the same November mid-month period.
For the remaining weeks of 2021, this market environment is in relatively unchartered territory given inflation traction fears, consumption growth trends, supply chain rebooting efforts and most recently, concerns of a new Covid variant, Omicron. Discussion and a wait-and-see perspective seem to be the rules of the day regarding inflation levels. In the near term, prices are moving upward, but the uncertainty is how “sticky” those higher prices really are. Over time, global supply chains will adapt, capacity constraints will ease, and earnings growth will normalize to more sustainable levels. Meanwhile the Fed will continue its path of unwinding asset purchases and balance sheet debt—a process already well communicated to investors. As I noted at the top of this piece, investors are facing a wave of uncertainty especially in light of the continuing Coronavirus risks, but even this setting will continue to provide investment opportunities as investors turn their attention to earnings sustainability, valuation, dividend streams and risk management.
Not Investment Advice or an Offer -This information is intended to assist investors. The information does not constitute investment advice or an offer to invest or to provide management services. It is not our intention to state, indicate, or imply in any manner that current or past results are indicative of future results or expectations. As with all investments, there are associated risks and you could lose money investing. Argent Financial Group is the parent company of Argent Trust, Heritage Trust and AmeriTrust.
