Authored by :
Michael G. Dow, CAIA, CFA, CPA, Chief Investment Officer
Julien R. Frazzo, Director of Risk Management and Securities Research
* * *
The Quick Facts
- The best October in six years for the S&P 500
- The 3Q earnings season has been decidedly robust relative to the economic quarter
- The yield curve flattened as investors questioned whether the U.S. can handle higher rates
- The Federal Reserve (the “Fed”) tapering of asset purchases is imminent but tightening seems unlikely until the second half of 2022
- The Fed recognizes inflation risk, yet remains patient on rates
The S&P 500 ended the month at a new all-time high, rolling up a gain of 7.0% for the month (+24% year-to-date) to notch the best October in six years. Some credit for the market resilience goes to the 3Q2021 earnings season that has delivered an almost unprecedented rate of positive surprises.
The economy is struggling with shortages across industries as global supply chains remain clogged. Supply constraints, which were worsened by a wave of Covid-19 infections driven by the Delta variant over the summer, helped restrain economic growth to its slowest pace in over a year in the third quarter. A decline in Covid-19 cases may encourage more consumption of services and curb demand for goods. The U.S. economy grew at a 2% annualized pace in Q32021. Consumer spending, which makes up 69% of the $23 trillion U.S. economy, increased just 1.6% for the most recent period, after rising 12% in the second quarter. Nevertheless, at the time of publishing, 56% of the companies in the S&P 500 had reported actual results for 3Q2021 with 82% of them beating EPS estimates. In aggregate, companies are reporting earnings that are 10% above estimates, which is above the five-year average.
Despite some notable drops in big tech stocks on the last trading day of the month following disappointing sales from Apple and Amazon, the broader market finished October with healthy gains. The tug-of-war between growth and value persisted with growth outperforming value by 3.6% in October. Since the beginning of the year, growth has modestly outperformed value. The Russell 1000 Growth is now up 24.2% year-to-date (YTD), 2.2% ahead of the Russell 1000 Value, up 22.0% YTD. International markets continue to underperform with the MSCI EAFE (Europe, Australasia and the Far East) up 11.5% YTD and the China-heavy MSCI Emerging Markets marginally down 0.3% YTD.
October Asset Class Performance
All eleven sectors finished higher in October, with Consumer Discretionary leading the way with a 12.1% return. Energy (+10.3%, +56.7% YTD) is the best performing sector YTD, helped by the WTI Crude Oil $/bbl 75% move higher YTD. Communication Services was the worst performing sector in October (+0.2%, +19.6% YTD). The reopening trade is very apparent, with Energy topping sector returns YTD at 56.7%, followed by Financials at 38.3% and Real Estate at 33.7%.
Investor focus this week will be on the Fed’s two-day policy meeting as we go to print. The Fed is expected to announce the start of tapering of its $120 billion in monthly bond purchases as a first step in paring back emergency measures to support the economy. Raising interest rates will be the next step of the Fed’s policy normalization. Fed Chair Powell recently acknowledged that the risks to inflation are to the upside but stuck with his base case that price pressures will eventually ease as supply-chain issues are worked out. Powell faces a conundrum when it comes to the labor market. He has suggested that a lot of slack remains, pointing to a 5 million shortfall in payrolls from the pre-pandemic level. Unemployment, at 4.8%, is well above February 2020’s 3.5%, while labor-force participation is down. Powell is betting that the dichotomy will be resolved by Americans returning to work and filling some of the 10.4 million open job positions as Covid-19’s latest wave subsides.
The bond market is already looking for higher rates, with the yield on the 10-year Treasury note closing October 6bps higher at 1.55%, after beginning 2021 at 0.91%. Signs that inflation is not calming down could push yields higher still. The 10-year/2-year Treasury spread tightened 15bps to 1.06%. Treasury yields remain historically very low when looking at 230 years of interest rate data. The CME FedWatch tool is now pricing a 78% chance of at least two Fed rate hikes by December 2022.
With regards to Washington policy, the range of outcomes is narrowing on fiscal negotiations. Momentum is building among Democrats to have a vote on the bipartisan infrastructure plan and an agreed-upon reconciliation framework over the next few weeks. House progressives could push back the vote on the bipartisan bill to get legislative text written for the reconciliation bill. Tax policy changes are a moving target but appear less onerous than once feared. A deal by year-end is likely.
The U.S. Dollar Index, (indicating the general international value of the USD), was stable in October with a monthly pullback of -0.1%. The WTI saw another double-digit spike of +11.9%. Gold finally caught a bid and was up 1.5% for the month at $1,783/oz. Gold remains one of the worst performing asset classes in 2021, with a -6.1% YTD return. Bitcoin had a strong month with a +40.4% return in October. Bitcoin is now up more than 110% YTD at $60,976 per bitcoin. The CBOE Volatility Index (or VIX), also known as the fear gauge, is back down from 23.1 at the end of September to a very mild 16.3 at the end of October. During the month of October, the VIX closed at its lowest level since before the pandemic at 15.01 on October 21.
Investment Summary – “Inflation, Rates, and Rotation” in an Era of Financial Repression
At Beacon Pointe, we remain “risk-on” (less so versus 3Q2021) given positive vaccine developments, 3Q corporate earnings surprises, reduced risk of a major tax rate hike, and favorable seasonality. We cannot ignore the massive monetary and fiscal support expected now and, in the future, but “stagflation-lite” is a growing concern on a cyclical basis. We prefer Equity and Alternatives to “safe” Fixed Income given the current and expected negative real yield environment. We are adding to our positions that reflect a rotation from U.S. Large Cap Growth to U.S. Large Cap Value, U.S. Small Cap, and EAFE (growth) given economic reflation. We are reducing the allocation to Emerging Markets (EM) equities given our less than optimistic views on China and other EMs. We are increasing the position slightly in Short Term bonds to protect portfolios from rising interest rates. We retain the inflation protection position in TIPs but are reducing Real Assets (Gold) while increasing the exposure to Hedge Funds.
Chart of the Month – A Dislocated Labor Market
The unemployment rate dropped to 4.8% in October, and there are a record number of job openings. There are still nearly 5 million less workers employed now versus February 2020. A subdued labor force participation rate is weighing on economic growth. The “quits” rate, a measure that calculates the percentage of the U.S. workforce that quit their jobs during the month, rose to 2.9%; this is the highest percentage ever reported. There is an acute labor shortage, and workers are able to command higher wages. The Fed will be watching this development closely in the coming months. Wage growth could turn a transitory inflation issue into a persistent one.
Major Asset Class Dashboard
Important Disclosure: This report is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. All investments involve risks, including the loss of principal. Investors should consult with thier financial professional before making any investment decisions. Past performance is not a guarantee of future results.
© Beacon Pointe Advisors. All Rights Reserved.