Previous week's Weekly market wrap

Expectations vs. Reality: Checking in on 2021 Views

The "buy the dip" mentality was on display again last week, as has been the case throughout 2021. After the September swoon that produced the first 5% pullback of the year, the stock market has regained its footing, spurred last week by a strong start to corporate earnings season¹. We came in to 2021 with a positive outlook, and the market has not disappointed. That said, not everything has gone according to plan. With three quarters of the year in the books, here's a look back at our key investment views from our "2021 Outlook: Back to the Future" that we penned last December, and our assessment of how trends that have played out this year may shape the path ahead.

Economy

• Last week: The September retail sales report showed a 14.3% year-over-year increase in retail spending¹. This is exceptionally strong by historical standards, reflecting the ongoing rebound in the economy. At the same time, this was half the growth rate seen in May and was the slowest rate of spending growth since March, reflecting the delta-variant-driven lull in consumption.
• 2021: Coming into the year we thought the ongoing reopening of the economy – spurred by the vaccine rollout – would drive strong GDP growth above 4% in 2021¹. The first half of the year lived up to that view, with GDP growth running well above 6%¹. The delta variant and supply bottlenecks have created an existing soft patch, with curbed household consumption likely to produce GDP growth closer to 2% in the third quarter¹.
• Going forward: We anticipate an uptick in activity as we round out the year, with 4%-plus GDP growth still looking achievable. The September retail sales report showed modest gains in food-services spending, suggesting delta-variant restrictions are still holding back overall leisure, entertainment and services spending growth. Nevertheless, holiday shopping and more than $2 trillion in accumulated household savings signal to us that consumer spending will see renewed momentum as we move into 2022, supporting a second wind for the economic expansion. Supply disruptions will be a fly in the GDP ointment as we advance, however, holding back growth in the near term. We expect the bottlenecks to begin to clear, though this is likely to transpire well into 2022.

^{Source: Bloomberg}

This chart displays GDP growth and Household Consumption.

Labor Market

• Last week: Initial jobless claims fell last week to 293,000, the first reading below 300,000 since March 2020. For perspective, initial claims peaked at a whopping 6.15 million in early April, when the unemployment rate just below 15%. This is an encouraging data point because we view declining initial claims as a leading indicator of positive employment conditions.
• 2021: We thought an improving labor market would be the backbone of the recovery coming into 2021, a view that has largely played out. We suspected the unemployment rate would approach or even pierce the 5% level, which has occurred as unemployment currently stands at 4.8% -- a sizable drop from 6.7% where we started the year. Job growth has been lumpier than we anticipated, with particularly underwhelming gains in recent months, reflecting the economic soft patch mentioned above. Helping offset this, however, has been stronger-than-expected wage growth, which is running at the highest levels in a decade, owed to another unique job-market condition that has emerged this year – labor shortages.
• Going forward: We expect job growth to pick up, supplying ample fuel for renewed momentum in the economy. We doubt the labor shortage will clear quickly given ongoing disruptions in the service, leisure and hospitality sectors. In any event, payroll and wage gains should see further support ahead.

^{Source: Bloomberg}

This chart shows the unemployment rate and initial jobless claims.

Bull Market

• Last week: Equities rebounded, returning to within 2% of all-time highs, as earnings season kicked off into high gear, thanks to strong results from the big banks¹. Improving sentiment has favored cyclical assets, with value and small-caps, along with the energy and financial sectors, leading the way recently.
• 2021: Heading into the year, we thought the bull market in stocks was poised to continue, supported by the economic recovery and rising corporate profits. Specifically, we thought earnings growth would be the primary guide for returns, with elevated valuations (P/E ratio) unlikely to expand further. This has been the case, with valuation levels holding fairly steady. However, gains in the S&P 500 have been particularly strong, thanks to robust earnings growth so far, including a nearly 100% year-over-year increase in the second quarter¹. We expected a rotation in equity-market leadership, which has occurred as the "risk on – risk off" oscillation in investor sentiment prompted periodic outperformance phases between value and growth investments.
• Going forward: Our positive outlook for equities remains in place, but we think volatility will become more prevalent. We think corporate earnings growth will continue, setting the pace for upcoming performance. At the same time, we think earnings expectations represent an area of vulnerability in the near term. The bar of expectations remains high, while the combination of rising labor costs, supply disruptions, less monetary stimulus, and the prospects of corporate tax hikes could temporarily dent the profit-growth picture. We doubt that will undermine the broader bull market, but we do think it could spark more volatility than we've seen so far this year.

^{Source: Bloomberg, S&P 500 Index. Consensus 12-month forward EPS estimates. The S&P 500 index is an unmanaged account and cannot be invested in directly. Past performance does not guarantee future results."}

This chart shows the Forward P/E ratio the S&P 500 index over time.

Fed Policy

• Last week: Incoming inflation data continue to support the case for the Fed to taper its bond buying. In addition, the conversation last week also included the potential for a shift in the central bank's leadership, with Chairman Powell's term ending in February. We think it's most likely that President Biden renominates Powell, favoring continuity and Powell's largely dovish-approach even amid rising inflation pressures.
• 2021: The vaccine rollout and economic rebound has progressed meaningfully since last December. As we anticipated, the Fed left rates at zero to support the expansion, but persistent inflation has accelerated tapering expectations into the final few months of 2021, slightly ahead of our view to start the year.
• Going forward: We expect the Fed to begin tapering as early as next month, with a gradual wind-down in bond purchases by mid-2022. We still believe actual policy tightening is still a ways off, with the first rate hike not likely for another year or so. This means monetary policy will remain more of a tailwind than a headwind for some time to come, extending the expansion and bull market.

^{Source: Bloomberg. Past performance does not guarantee future results}

This chart shows U.S. 10-year yields and the Federal Reserve Balance sheet.

Interest Rates

• Last week: Ten-year benchmark rates rose above 1.6% last week, reaching the highest level since June, spurred by the release of the September CPI report, which showed inflation continues to run hot. Core inflation is up 4% year-over-year, with the headline figure coming in a 5.4%, as food and energy prices rose materially in the month. The rise in inflation not only shown up in prices for consumer goods and services, but also on government programs. The cost-of-living adjustment for Social Security was announced last week, and benefits will rise by 5.9% in 2022, largest increase since 1982.
• 2021: We expected longer-term interest rates to rise moderately this year, supported by our view that inflation would pull back from its highs but would settle in at a higher level than the Fed or market was anticipating. While this transpired, the path was slightly different, in that inflation pressures have been more persistent (thanks to ongoing supply-chain issues) and 10-year rates have increased in uneven fashion that has included two surges (Jan-Mar and Aug-Oct) rather than gradually.
• Going forward: Ten-year Treasury yields began the year below 1%, so the move north of 1.5% is noteworthy. Inflation and monetary-policy conditions pose further upside for long-term yields, though we don't anticipate dramatically higher rates (north of 2%) this year, which means rates are not yet at risk of undermining the economy or equity-market valuations. With some time before the Fed hikes its policy rate, we maintain our view that the yield curve has scope to steepen further. Historically, periods of yield-curve steepening have been associated with positive equity-market performance.

^{Source: Bloomberg. Past performance does not guarantee future results."}

This chart shows core and headline inflation.

Craig Fehr, CFA
Investment Strategist

^{Sources: 1. Bloomberg}

Weekly market stats

^{Source: Factset, 10/15/2021. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results. * Morningstar 10/17/2021}

The Week Ahead

Important economic data being released this week include the PMI index, Industrial Production, and the LEI index.