Market Data for the quarter ended September 30, 2021:
- S&P 500 Stock Index: 4308, up 0.2%
- Ten-year Treasury Note Yield: 1.53%, up .09%
- Gold: $1,753 per ounce, down 1.0%
- Oil: $75 per barrel, up 2.1%
US stocks eked out a slight gain in the third quarter, as their initial exuberance was tempered in the month of September by inflation anxiety, the possibility of tighter monetary policy, higher bond yields, and another episode of US debt ceiling madness.
On the first three concerns, the reopening of global economies has not gone as smoothly as hoped. Global supply chains have been snarled by the pandemic and remain under pressure by the spread of Covid’s delta variant. Shortages of manufactured goods and commodities are being experienced worldwide, driving inflation indices to multi-decade highs. The implications from this scenario are higher bond yields and a potentially tighter monetary policy. As low interest rates and ample market liquidity have been the driving forces behind the powerful rally in stocks over the past 18 months, a significant change in monetary conditions could halt or reverse stocks’ heretofore relentless momentum.
While we remain skeptical that the supply chain-driven inflationary dynamics of economic reopening represent a permanent shift higher in the rate of inflation, their persistence into next year could indeed force the hand of central banks to tighten policy and restrict liquidity, thus damaging global stock markets. However, we believe that this issue that will not come to a head until sometime in 2022. For the remainder of 2021, strong corporate earnings growth and continued robust liquidity can propel stocks to new highs barring one significant roadblock: the need to raise the US debt ceiling.
As has become commonplace during Democratic Presidential administrations, Congressional Republicans are refusing to cooperate in lifting the “debt ceiling” of the Federal government. The debt ceiling is an anachronism that requires Congress to increase the Treasury’s allowance for borrowing in order to fund the previously authorized operations of the Federal government, including the military and major social programs such as Medicare and Social Security. Failure to do so would result in a default on US Treasury securities.
Given that US Treasuries and the dollar underpin global financial markets, a US default would almost certainly create a global financial crisis and devastating economic recession. As such, the Republicans are likely bluffing and attempting to make life difficult for the Democrats. However, the ever-present problem with brinksmanship of any kind is the potential for miscalculation that results in catastrophe.
While the probability of an actual default is low given its devastating consequences, the mere possibility will likely increase pressure on markets as the ultimate breakpoint draws near – estimated to be sometime in late October or early November. Our view is that the market will not be able to resume its advance until the matter is resolved and would not be surprised if the market experiences increased volatility on account of the debt ceiling imbroglio in the weeks ahead.
In summary, we believe stocks can enjoy a strong rally into the end of the year given growing earnings and still robust market liquidity. However, until the debt ceiling issue is resolved, the continuation of the rally will likely be delayed. If an actual default were to occur, a market crash would become a very real possibility. Because of this, default is highly unlikely, but one cannot be completely sure given the inherent risk of miscalculation when the tactics of brinksmanship are at play.
Assuming a default is avoided, we expect the US stock market as represented by the Standard and Poor’s Five-hundred stock index to close the year above today’s price level, perhaps as high as 4600. In the normal course of trading, we can also foresee the index trading as low as 4100. It ended the third quarter at 4308. In the unlikely event a default does occur, all bets are off and a significant decline of 20 to 30%, at least, would likely be in order. Given the remoteness of this possibility, we are not changing our investment posture. However, it is a scenario one must be aware of given the severity of its consequences.
As always, we appreciate the trust and confidence you have placed in us. We are always available to discuss your asset allocation and the investment environment more broadly, so please do not hesitate to contact us with your questions and concerns.