Market Fears Begin to Fade

Over the past several months we’ve been highlighting some of the primary fears that were hanging over the market. There was a steady drumbeat about rising COVID-19 cases, hot inflation, fiscal policy confusion, overvalued markets and fears the Federal Reserve would err. Markets remained range bound for some time, as the view ahead was cloudy. But without fail, we encouraged long-term investors to remain — to refrain from trading around these narratives and risk derailing a well-constructed long-term financial plan. Repeatedly, we reminded investors that these fears would eventually wane in Q4, and the economy’s stellar fundamentals would shine, bolstering confidence and lifting the fog.

Well, here we are. Despite supply chain logjams and higher input costs, corporate earnings have blown past expectations. Perhaps markets underestimated the resilience of businesses and consumers. The Fed, for its part, is attempting to land the plane smoothly and will begin tapering its asset purchases this month — given the lack of fanfare, you may have missed Chair Jerome Powell’s news conference this week. COVID cases are on the decline, children are eligible for vaccines, and Pfizer last week announced its experimental antiviral pill can cut the risk of hospitalization or death by 89 percent. It led former FDA Commissioner Scott Gottlieb (a Pfizer board member) to hypothesize an effective end to the pandemic in January. Hiring momentum is picking up (as we anticipated) as kids are in school and offices reopen.

Across the board, as we expected, the shadows that were hanging over markets are fast receding, and the focus is now on those fundamentals. And with that, let’s take a closer look.

Wall Street Wrap

Fed Will Start Tapering This Month: The tapering has arrived, but markets don’t seem to mind. Fed Chairman Jerome Powell last week announced the Fed would begin paring its $120 billion in monthly asset purchases by $15 billion ($10 billion in Treasurys and $5 billion mortgage securities) each month. That puts the central bank on pace to fully withdraw its pandemic-era economic support program by the middle of next year. Of course, Powell said the Fed would continue to monitor the economy and adjust if necessary.

It’s a move the Fed has forecast for months now, so there were no surprises when the Fed’s tapering plans became “official,” and markets love being underwhelmed by the Fed. So Powell has successfully started turning the ship without causing any seasickness. Keep in mind, even when the Fed ends its asset purchases, it will continue to hold those assets on its balance sheet and maintain very accommodative conditions.

On Inflation: Powell also made comments that are much in line with what we’ve said about the pandemic-driven recession and the current bout of inflation we’re experiencing. The recession of 2020 wasn’t traditional in the sense that there were excesses in the economy that needed to be recessed. Rather, it was a health-driven event driven by intentional actions to limit the spread of the virus.

Our current bout with inflation isn’t traditional, either. Powell said inflation isn’t driven purely by economic fundamentals (we’ve noted as much here several times); rather, it’s driven by echoes of the pandemic, or supply and demand imbalances as economies rapidly reopen around the world. Traditionally, extended bouts with inflation are sustained when the economy lacks productive capacity to meet demand. All the data indicate that’s not the case right now. And although elevated inflation is forecast to stick around well into next year, Powell remains confident it will subside as the economy fully recovers from the echoes of COVID-19.

The ISMs: The ISM Manufacturing read for October was strong again. Although it fell a tad, down to 60.8 from 61.1 in September, it remains in elevated territory; and this was the 17^th consecutive month of expansion in the sector (anything above 50 indicates expansion). All segments of the sector continue to feel the pinch from record-long lead times for critical materials, shortages and rising commodities prices. Despite these challenges, survey respondents remain quite optimistic. For one, inventories are building at the factory level, as that gauge hit its highest level since 1984. On the other side, customer inventories remain low. However, you’d rather see inventories building at the factory level rather than at the customer level (which would be an indication they can’t sell their wares).

The services side of the index knocked it out of the park, supporting our thesis that as the economy reopened, consumers would shift from a “stuff”-oriented recovery to a services recovery. Services accelerated notably in October, rising 7.5 percentage points to 69.8 in October, up from 62.3 in September. That’s an all-time high for the series and the 17^th consecutive month of expansion. Seeing a sharp transition to services is encouraging for two reasons: First, the U.S. is primarily a services economy (roughly 70 percent of GDP); secondly, as consumers spend more on services, that should help release some pressure on constrained supply chains and buy producers time to work through backlogs.

Hiring Is Accelerating: We’ve told investors to remain patient with the labor situation, as we expected a boost to hiring as enhanced unemployment benefits expired and people felt more comfortable returning to work and school. We’re seeing that in data now. The U.S. added 531,000 jobs in October, with 163,000 additions in leisure and 119,000 in bars and restaurants. What’s more, prior months were revised upward by a total of 235,000 jobs. Unemployment ticked down to 4.6 percent in October from 4.8 percent the month prior. Women were disproportionately affected during the pandemic (many work in fields that involved human interaction or put careers on hold to care for children stuck at home), but 200,000 women joined the workforce in October, a small but positive sign that things are getting back to normal.

The Week Ahead

Here’s a look at what’s on tap this week:

• Tuesday: The NFIB small-business index for October is due. This monthly report is always a nice gauge on how the largest cohort of business owners feels about the economy. Labor and supply chains have been the running theme, but with a nice uptick in hiring in October we’ll be curious to see if that’s carrying through to smaller enterprises.
• Wednesday: Tired of hearing about inflation? Well, strap in for more. CPI and Core CPI for October will be released in the morning, and that could have an impact on trading if expectations are exceeded or inflation surprises to the downside, which would be applauded in markets.
• Friday: The week closes with the University of Michigan Consumer Sentiment Index. We’re heading into retail’s prime time, so the consumer will be a big focus as we head into the final stretch of 2021.

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