Client Letter 2021 Q3

Q3 2021 Market Results

The stock market was mixed in the third quarter.  It started strong, and except for a short pullback in mid-July stayed strong through the end of August.  September on the other hand was just the opposite with a continued drawdown over the course of the month.  For the quarter the S&P 500 was up 0.58% making it 15.92% for the year so far.  International markets were down -0.45% for the quarter and are up 8.35% for the year.  Emerging markets were down -8.09% for the quarter are down -1.25% for the year.  Bonds were up 0.05% for the quarter and down -1.55% for the year.  Short treasuries were up 0.06% for the quarter and down -0.04% for the year.  Bonds continue to struggle with the lack of clarity on inflation and the effect on interest rates.  As expected, and mentioned last quarter, bonds remain in a difficult situation due mainly to inflation concerns.  I still believe that will improve as we progress through 2022.

Portfolio Thoughts

Portfolios performed mixed in the third quarter.  Tactical portfolios were down slightly in the moderate to more aggressive risk profiles, and slightly positive in the more conservative risk profiles.  That story was essentially the same for Strategic portfolios.  Momentum portfolios were positive and outperformed both tactical and strategic portfolios as the U.S. focus continues to work.  Although the gains were small, the lack of exposure to International and Emerging markets provided the performance boost.  Our Capital Preservation portfolio was also down slightly for the quarter, with global bonds playing a role in that.

September has historically been a volatile month for the stock market, especially in years when the market has been strong going into September, as it has been this year.  From what I see, all indicators suggest that volatility will carry into October.  However, as maddening as the volatility can be, I’m not overly concerned.  Yes, we saw a new all-time high for the S&P 500 in early September, then watched it drop for the rest of the month.  And yes, we may still see lower market levels through October.  But history suggests that we will see recovery into November and December with the year-end still seeing strong, positive results.  No guarantee, but that’s my take on what I’m seeing.  I do not see any signs, or underlying fundamentals that suggest we are on the verge of a major market correction.  I see this as somewhat normal market volatility that we live with as best we can because it’s impossible to predict when it starts or ends.  We continue to believe the S&P 500 will end 2021 in positive territory with our year-end projection now revised up to 4,450, slightly above where we ended the third quarter.

Q3 2021 Notes

Let me start this section by reviewing what is happening at the Federal Reserve (Fed).  The Fed has been extremely easy with its monetary policy, keeping short-term interest rates very low and using their asset purchase program (a.k.a. Quantitative Easing) to help control longer term interest rates.  This has allowed the pandemic generated recession to recover quickly and across most economic measures.  But the economy is not fully recovered and now inflation has become a concern for the Fed.   The Fed has all but announced the beginning of the end of Quantitative Easing.  Most analysts now believe Easing will begin declining in late 2021 and completely end by the middle of 2022, with short-term interest rate increases shortly thereafter.  The logic here being that with an economy that is recovering monetary support can start to be reduced.  Then, as that support wanes, interest rates can shift up to prevent inflation from becoming more of a problem.  Overall, I believe the Fed has done a good job in managing policy, and just as good at communicating their intentions.  Something previous Fed teams have not done so well.  As a gauge, the 10-year treasury rate as of the end of the third quarter was 1.46%.  I expect that rate to be more like 1.75% by the end of 2022.

Looking at more global affairs, it would be hard not to say that the biggest event from the third quarter was the U.S. withdrawal from Afghanistan.  After 20 years of war in that country, and a failed attempt at nation-building, the U.S. packed up and left Afghanistan by the agreed upon date of August 31, 2021.  The images from Afghanistan reminded many of the U.S. withdrawal from Vietnam and the helicopter driven evacuation of Saigon.  The images stood in stark contrast to the expectation that the Afghan government and military would be able to resist full takeover by the Taliban.  In the end, the Afghan government fled the country and the military collapsed without a single shot fired.  All the stories of progress with the training of the Afghan military, and the billions of dollars spent, proved to be no match for the fully motivated Taliban.  I try to be objective on these kinds of events.  Yes, images of the evacuation were ugly, and the suicide terror strike that killed American soldiers was tragic, but I’m not entirely sure how you end such a long operation, and remove people and equipment, without it looking chaotic.  So, I want to avoid the Republican approach of condemning the President and his staff, often without any real constructive views of what they would have done differently.  On the flip side, it seems hard to understand why so many Americans, and U.S. friendly Afghans were not evacuated sooner, only to be left stranded with limited options and facing what is expected to be a very unforgiving Taliban.  Was the evacuation planning done as well as it could have been?

Politically, the U.S. is gearing up for what looks to be a busy, and contested, political period into year end.  At the top of the agenda is the much talked about $1.2 trillion traditional infrastructure bill.  One that has already passed bipartisan in the Senate and awaits approval from the House.  However, progressive House Democrats are holding up the traditional infrastructure bill to ensure they pass the $3.5 trillion (or higher?) human infrastructure bill supported by President Biden.  This bill would be the most radical change in government social support since the Roosevelt New Deal or the Johnson Great Society.  The infrastructure bill has high approval ratings as most Americans feel infrastructure has suffered in the last 20-30 years.  Tying the two bills together risks having the traditional infrastructure bill not pass if the human infrastructure bill fails to pass.  Losing both bills would be a blow to Democrat’s agenda and make their mid-term election challenges even more difficult.  Although I appreciate the progressive’s strong desire to pass the human infrastructure bill, I think losing the traditional infrastructure bill would be short-sighted.  Personally, I support the traditional infrastructure bill because I do feel our infrastructure has suffered.  The human infrastructure bill I don’t support.  Not because there isn’t a need for a stronger social safety net, but because we spent multiple trillions of dollars in COVID relief, and I think we should get past COVID to a fully recovered economy before we consider spending more multiple trillions.

As always, we will watch and research the global economy and make investment choices to the best of our ability for each and every client portfolio.  If you have questions about your portfolio, our views expressed in this letter, or anything else financial, please do not hesitate to call.

Best Regards,

Jim