by Shawn Narancich, CFA
Executive Vice President,
Equity Research and Portfolio Management
Policy Shifts
As autumn dawned this week, investors witnessed the first move by a developed market’s central bank to raise interest rates since the COVID-19 pandemic began. No, the Fed didn’t raise rates. Rather, it was Norway’s central bank that moved its short-term interest rate target off the zero bound, citing improved economic activity that no longer justifies such monetary policy accommodation. Despite the Delta variant and supply chain issues causing a “speed bump” in third quarter economic growth, the U.S. Federal Reserve recognized as much at their Federal Open Market Committee meeting this week. Fed Chair Powell announced that tapering of the central bank’s quantitative easing program is set to begin later this year, most likely following its next meeting in November.
A September to Remember?
Many believe the Fed would have been justified in beginning to reduce its $120 billion per month purchase of U.S. Treasury and mortgage-backed bonds today. However, we believe the Fed wants to see one more jobs report that is set to be announced in early October before beginning to taper. As well, the Fed is aware of the supercharged political environment that could cause the type of market volatility that, in its worst iteration, might cause the Fed to delay. Dubbed the “September to Remember” by our political consultants at Strategas, this month is witness to the histrionics of Congress raising the nation’s soon-to-expire debt ceiling, as well as negotiations to pass a massive new stimulus and tax package. As the chart below demonstrates, stock market volatility of the type investors witnessed earlier this week could continue and draws a parallel to that experienced eight years ago.
Source: Strategas
To name a few of the similarities between today and 2013, the stock market produced unusually good returns year-to-date; the Fed is communicating a change in monetary policy; and the U.S. Treasury’s debt ceiling is on tap to be increased amid competing fiscal ideologies. Ultimately, the debt ceiling will be increased — the U.S. has no choice! While the ultimate outcome of additional government spending and tax change is hard to predict, we believe that Republicans and Democrats will coalesce around the infrastructure portion of stimulus and that both personal and corporate tax rates are likely to be increased in 2022.
Systemically Irrelevant
Meanwhile, we do not expect the likely default of Chinese property developer Evergrande to metastasize into a systemic threat to our financial markets. U.S. credit default swaps, which measure the cost of insuring debt against default, barely budged on news Monday that highly indebted Evergrande is experiencing financial distress. Yes, some global bond funds own Evergrande bonds, but the threat is much more China-centric and not likely to cause waves in the developed markets.
Earnings Indigestion
Although late September is not typically notable for earnings news, a couple odd fiscal year companies reported attention-grabbing results this week. Investors are taking note of the supply chain disruptions and wage inflation that caused shipping company FedEx to miss Wall Street profit expectations. Earnings fell 11% in the quarter and the stock retreated as management reduced its full-year earnings forecast. With over 70 cargo ships at anchor offshore Long Beach, California, another blue-chip company succumbed to the currently challenged supply chain environment — Nike. The footwear titan reported better-than-expected earnings that grew at a healthy rate. However, its sales missed estimates and management reduced full-year sales growth expectations because of an inability to efficiently source footwear and apparel. Thirty percent of Nike’s apparel and half of its footwear is manufactured in Vietnam, which is currently experiencing COVID-19-related factory closures. We believe that demand for Nike’s products remains healthy, but supply chain issues are delaying the type of growth it was on track to achieve this year.
Staying the Course
With inflation running notably above the Fed’s 2% objective and evidence of its underlying causes beginning to impact earnings, we are keenly attuned to the risk of profit shortfalls that could impact bottom line expectations in 2022. As it stands, we foresee some degree of earnings growth for the S&P 500 next year, but it is more likely to be at single-digit levels far short of the 50%-type growth expected this year. Earnings power in 2022 is also likely to be impacted by higher corporate tax rates likely to be legislated. Nevertheless, the yield on bonds is too low to create much competition for stocks. Accordingly, we remain underweight the former and overweight the latter.
Takeaways for the Week
Stocks staged a comeback from early week volatility to finish the week higher
Developments at the Fed, among DC lawmakers and with earnings are likely to create added volatility into year-end