The Ifs, Ands and Buts About Markets
Author: Kevin McCreadie
October 14, 2021
As markets grow more uncertain, now is not the time for investors to grow complacent, says AGF’s CEO and Chief Investment Officer.
Equity markets haven’t been this volatile since perhaps the start of the global pandemic almost 20 months ago. What’s causing so much uncertainty?
There’s always uncertainty in markets, but it does seem like more variables are at play currently than perhaps is normal. And just when investors feel like they might have a grip on some of them, they prove elusive, or circumstances change and bring about new considerations. In fact, it’s no wonder that equity markets have been so volatile lately.
Perhaps the best example of this is the inflation debate. In the span of just a few months, markets have gone from believing higher prices are a long-term inevitability to believing – much like the U.S. Federal Reserve – that they are a transitory phenomenon to now, once again, believing inflation may indeed be more persistent and may ultimately force the Fed to raise rates sooner than expected and dampen economic growth more than is already largely expected. Remember, U.S. GDP growth was 6.7% in the second quarter of this year, according to the U.S. Department of Commerce and there’s almost no chance of it not slowing dramatically from here.
Of course, there’s good reason for the latest about-face. While maintaining its stance that U.S. inflation will drop closer to 2% next year, the Fed recently changed its forecast and predicts the Consumer Price Index will remain above 4% for the rest of this year. In part, that’s because global supply chains are still not operating smoothly and ongoing disruptions – which run the gamut from the container market and shipping routes to ports, air cargo, trucking and railways – may get even worse if consumer demand increases any further during the upcoming holiday season.
Meanwhile, soaring energy prices around the world only complicate matters. Oil is at a seven-year high [Bloomberg data shows] because of growing demand and OPEC+’s decision not to significantly increase production while natural gas, coal and other power prices have also hit new highs, again because of strong demand and supply under-investment, but also due to the intermittent and lengthy transition to renewable power. Moreover, there may not be a near-term solution to the crisis these higher prices are creating in parts of Europe in particular, especially if a cold winter exacerbates the situation.
If inflation seems like a moving target, what should investors make of the latest U.S. employment figures? Clearly, the strength of the labour market plays an equally important role in what the U.S. central bank does over the next year.
The Fed has stated that it wants to see full employment before it starts to raise rates, which likely means an unemployment rate lower than 4% and maybe closer to 3.5%. To that end, the September jobs report seems to be a definitive step towards a rate hike sometime in 2022. The unemployment rate dropped to 4.8% from 5.2% in August, marking the 14th time it has declined in the past 17 months, according to the U.S. Bureau of Labor Statistics.
However, this doesn’t tell the full story. The jobs report also shows that U.S. employers added just 194,000 new jobs last month, which, for the second month in a row, was far fewer than expected. The main reason for the “misses” is likely the delta variant of the COVID-19 virus, which left potential employees still sitting on the sidelines. Late summer was precisely when infections and hospitalizations from it were at their highest. The question now that delta appears to have subsided is whether this was just a blip in the data or longer lasting.
Investors will know more about what the Fed thinks at the conclusion of the Federal Open Market Committee’s (FOMC) next meeting in early November. It’s been widely expected that the Fed will announce plans to begin tapering bond purchases next month and lessen the liquidity it has provided to markets, but, if it doesn’t, that could signal to markets that full employment – and therefore higher interest rates – may not be so quick to come after all.
Given these ifs, ands, and buts, is there anything that investors can hang their hat on, so to speak?
The market has been bolstered in recent days knowing the U.S. Treasury won’t default on its debt following the U.S. Senate’s decision to pass a bill raising the debt ceiling into early December. While it’s only a temporary fix, it at least takes one near-term headwind off the table and should be a huge sigh of relief to investors. That said, U.S. President Biden still hasn’t gotten his major infrastructure legislation passed through U.S. Congress and the more time passes, the less clear it becomes what the market thinks about the US$2-trillion plan. On the one hand, fiscal stimulus of this magnitude could give the U.S. economy a much-needed boost, and precisely at a time when it may need it most. On the other hand, it raises the spectre of higher taxes that many believe is a risk that outweighs the legislation’s potential benefit.
Then, aside from all that, investors must also contend with another U.S. earnings season, one that may be less rosy this time around than last. S&P 500 Index earnings for the third quarter are expected to slow dramatically in comparison to the second quarter of this year when earnings growth soared from the effect of very favourable year-over-year comparisons. Already, several companies have warned about profit margin pressures being exerted by supply-side disruptions that are leaving them without enough goods to sell, which puts pressure on revenue growth, while also forcing them to contend with higher costs.
In other words, now is not the time to be complacent. And investors who maintain a well-diversified portfolio that includes a mix of stocks, bonds and alternative assets and strategies are likely more equipped to handle what the market dishes out next.
Kevin McCreadie is Chief Executive Officer and Chief Investment Officer at AGF Management Limited. He is a regular contributor to AGF Perspectives.
About AGF Management Limited
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