Shifting Trends
During September markets fell on concerns around a slowdown in the rate of economic growth along with added distractions including increased regulations in China and the Fed indicating it may begin to slow its base of monthly bond purchases. Now, three weeks into October, those fears seem to have subsided. In fact, if the S&P 500 can hold its ground this coming week, the index’s +5.6% return thus far in October will make it the best performing month thus far in 2021.
This past week marked the first full week of third quarter earnings releases. Results have thus far been better than expected. Companies in the financials and consumer sectors have exhibited better than expected strength to their businesses. Technology oriented businesses, to the contrary, exhibited some cracks this past week. Of note was social media company Snap. While third quarter results met expectations, they offered a rather disappointing outlook. One of the reasons cited was a pullback in their customers’ advertising spending as supply chain challenges are leading some to question the need to spur demand for incremental sales. An alternative shot across the bow came from Intel, which surprised Wall Street by announcing a multi-year investment plan that will both compress margins and reduce cash flow.
Beyond stocks, the bond market has been under pressure from rising interest rates. This past week the yield curve shifted higher as interest rates on Treasury bonds two years and longer were up between 5 and 10 basis points. Since September 21st, the day before the Fed’s most recent meeting, yields on the same group of maturities have risen a quarter of a percent, or more, depending on the maturity. Yields on the 10-year Treasury are now encroaching their highest level since March of this year. The 2-year yield closed the week out at 0.46%, its highest yield since March of 2020.
The initial shift higher in rates was in reaction to the Federal Reserve’s September announcement that they might begin the process of tapering their asset purchases before year end. However, over the past month, economists and market participants are also beginning to conclude that inflationary pressures are not entirely transitory. As such, there is a greater expectation for higher inflation over the next few years, which has only boosted rates further. Lastly, we believe that two-year Treasuries are also being impacted by rising probabilities that the Fed may increase interest rates in 2022. As of week’s end, the market implied probability of a ¼ percent increase in the Fed Funds rate by June of 2022 is now at 70%.
There are clearly shifting trends around the economy, interest rates, and trends in corporate earnings. This past week reinforced the benefits of diversification in this climate. Stocks, as evidenced by the S&P 500 were up +1.6%. Alternatively, bonds as measured by the Bloomberg Barclays U.S. Aggregate index dropped -0.4% with higher rates serving as a drag on results. We continue to expect stocks and bonds to ebb and flow, although as the economy and market themes evolve there is a benefit to keeping some balance.
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