Contributing Factors

We look back at Q3 2021 and highlight factors that contributed to market movements.

Financial market results for the 3rd quarter of 2021 were relatively muted start to finish, and interest rates ended the quarter at only slightly different levels than they began the quarter. Intra-quarter, however, the three months were eventful; the U.S. stock market experienced periods of price movements ranging from +5% to -5%, while longer-term interest rates fluctuated more than in recent history. Financial markets absorbed new economic data and moved swiftly to adjust to new expectations.

Of the economic data released during the quarter, inflation seemed to receive the most attention. Inflation reports showed year-over-year changes in prices of goods and services were north of 5%, a level last seen for only a moment in mid-2008. Why is this important? Inflation impacts how we spend, save, and invest for the future. The level and related change in inflation impacted companies and industries to different degrees. Company stock prices reacted, given that inflation can influence sales, operating costs, and subsequent profits. This past quarter we witnessed periods of increased market volatility, we believe, in part due to the market adjusting to the current level and changes in inflation.

A contributing factor to the recent inflation can be tied back to the labor market. The labor market has remained uneven, creating labor supply shortages. During the quarter, the number of job openings exceeded unemployed persons – there were more jobs available than those out of work. Although this has occurred before, what is unusual this time, is that it is occurring during a period of economic recovery. The answer to this unevenness is not on the surface, as there are several factors involved: health concerns, lack of childcare for families, workers changing industries, and skills gap. These factors could remain within the economy for some time.

The dual mandate of the U.S. Federal Reserve (Fed) is to control price levels (inflation) and seek maximum sustainable employment. Currently, there’s a conflict between these two mandates. Inflation, as we noted, is elevated; however, the jobs market is far from maximum sustainable employment. Because of this, the Fed continues the path of monetary stimulus, policy actions aimed at increasing economic activity further.

The U.S. stock market (S&P 500) returned +0.58% during the quarter, while international stocks returned -0.45%. The U.S. bond market returned 0.05%. For the year, stock markets are performing exceptionally well, with global stock markets returning about 11% through three quarters of the year. The S&P 500 level closed the quarter at 4,307, and the 10-year U.S. Treasury Bond, if purchased at quarter-end, would yield 1.52% per year for ten years.

Looking ahead, the current supply shortages in the economy and the Fed’s actions aimed at fixing the labor market could lead to continued levels of higher inflation. Low-interest rates have been and could continue to be a tailwind for stock prices. Structurally, stocks are more finite in supply and provide claims on future profits of the underlying companies. Thus, stocks historically have been good diversifying assets to own in periods of elevated inflation.

Managing investments and planning for the future requires evaluating and diversifying against a multitude of uncertainty. Uncertainty can be related to the stock market, interest rates, changing tax policies, longevity, and inflation. A well-diversified portfolio is designed for many outcomes, creating confidence in periods of uncertainty. 

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