In general, 2021 has been a productive year for investors so far. Most of the major stock indices in the US and overseas have been in positive territory since the start of the year, and the global economy continues despite ongoing headwinds from Covid. For most of the summer, US markets were on cruise control, posting unspectacular but steady gains while avoiding significant losses. Then came September, and in the typical seasonal market pattern, things got a little choppy. As of this writing, the S&P 500 index is down about 4% from its all-time high in early September.
Companies have started to announce their third quarter results and Wall Street expectations are high that the results will be very strong. However, several hurdles have emerged in recent weeks that could affect investor sentiment towards the end of 2021. There’s good news too, but first the hurdles. . .
Problems in the supply chain
Dozens of container ships are anchored here on the west coast at ports, waiting to be unloaded. You can see half-empty shelves in many shops. Items purchased online seem to take an unusually long time to ship. Costco is rationing toilet paper again. Today, supply chain disruptions are ubiquitous and pose huge challenges for companies as they try to position themselves for the upcoming holiday shopping season. Final demand does not seem to be an issue for most companies. . . but if you can’t deliver the products, you won’t be able to post the profits. The effects of today’s supply chain confusion will be felt in upcoming inflation readings, as well as corporate sales and profit margins in the fourth quarter.
Fed tapering on tap?
The Federal Reserve has announced that it may “reduce” its monthly bond purchases of $ 120 billion as early as next month. With consistent buying pressure on the bond market, the Fed has tried to keep interest rates low and liquidity high. It has largely achieved these goals, but has massively increased its own balance sheet. (The Fed’s balance sheet is now $ 8.5 trillion.) If the Fed pulls out of the bond market for good, yields could tend to rise as the biggest (and most avid) buyer has been removed from the equation. However, bond investors have had months to prepare for this eventuality, so it is possible that it is already priced in. It is not currently in the Fed’s short-term plans to start raising rates, but it could start late next year, according to the Fed’s “dot plot”, which outlines Fed members’ expectations of when they could start Raise interest rates.
Inflation is still hanging around
Inflation poses a threat to the economy and is rife in the minds of investors as a significant short-term risk. The Fed has maintained its position that much of the inflation we see now will be temporary rather than permanent. Since I addressed this issue in my last quarterly letter three months ago, the situation has deteriorated somewhat. There is an abundance of labor, raw material prices continue to rise, and supply chain problems have worsened. Each of these factors contribute to price increases at both the producer and consumer level. Should inflation data remain high through 2022, the Fed could be forced to reconsider its position. Stickier inflation could force the Fed to hike rates sooner and faster than it wants, and that would likely throw a wet blanket on equity markets.
Companies are healthy and growing
Despite these hurdles, the companies are financially well positioned and should see their earnings increase sharply in the third quarter. The profit margins are also robust. Earnings growth is likely to slow if we overtake poor financial results at the start of the pandemic, but the growth outlook for 2022 looks constructive, even as some economists begin to lower their forecasts for the next year. However, given these risks, investors should be careful not to change their strategy as there is almost always something to fear when it comes to investing. The time to really worry is when no one can find something to worry about.
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