Marco Fragnito, Managing Principal | Robert R. Fragnito, Financial Advisor & Portfolio Manager
- Economic data continues to leave room for concern, yet unlikely Fed taper a positive for the market.
- After following a more prudent approach in light of changes since 2020, we have re-aligned our sentiment for future returns in the market.
YEAR TO DATE REVIEW
In August, all three major averages notched new record highs. Investors scaled the wall of worry along the way, choosing to focus on a continued accommodative Federal Reserve and expectations that it would remain so into the foreseeable future. The major averages have recorded year-to-date gains of 21.57% for the S&P 500, 18.94% for the NASDAQ Composite and 17.04% for the Dow Jones Industrial Average.
There were numerous reasons for investors and us at MCF to remain concerned. The most persistent concern remained over the headlines related to Covid-19 and its many variants. Another concern was China’s renewed government crackdown on its tech-related companies and a recent slowing of the Chinese economy. Here in the U.S., domestic economic data remains very uneven and generally below expectations while inflation gauges remain at elevated levels, with readings above 5% for the last few months. For example, while July payrolls showed a monthly gain of 943,000, recently released numbers for August showed a gain of only 235,000 well below consensus expectations of 720,000. While the core consumer price index (CPI ex-food and energy) rose 0.3%, the smallest uptick in four months, the headline figure still pointed to a 5.4% year-over-year increase the highest since 2008. All of this has forced consumer confidence as measured by the University of Michigan sentiment to near 10-year lows.
The most important highlight for investors was the parade of hawkish comments from Federal Reserve officials as they continue to signal a willingness to begin tapering bond purchases sooner rather than later. In simple terms, they are purposing reduced levels of money printing which has been in part a reason for the higher-than-expected positive performance seen in equity markets. A reduction in the liquidity in financial markets may lead to a larger than expected market correction and unintended consequences for the real economy.
While there may be many other events or reasons for concern, whether that be the Biden administration’s economic and foreign policies or other geopolitical events, we at MCF remain focused on that which we can quantify and factor into our data analysis.
We want to take this opportunity to make note of the fact that for months our market commentaries have not been published, and we want to offer a brief explanation for our many readers. In the past 6 months we have been observing and assessing how much the new administration has been impacting the data related to asset allocation, economic data, market data and most importantly individual holdings. At the same time, we at MCF had been planning the opening of our second office in Dallas, Texas with Robert at the helm.
At the start of the year and for most of the first half, while we remained positive on equity markets, we recommended a more cautious approach going forward. This was driven in large part by our expectation that while we would experience strong growth, it would fall short of expectations, as uncertainty remains around Covid-19 and to a lesser extent the Biden Administration’s possible economic policy shift. In fact, Covid-19 and its variant concerns have materialized in witnessing slowing economic growth, while economic policy changes have proven to be muted. In turn, the equity markets have delivered very good performances as measured by the major indexes. While our cautious approach may have reduced returns very slightly in our portfolios, we felt it prudent to observe how the new administration would impact equity markets and our portfolio holdings.
We are now recommending that investors re-align portfolios to a more bullish weighting, while at MCF we look to be fully invested based on our data driven approach. This is despite the possibility of a stock market correction in the next few weeks. We are looking at any pullback to increase the pace of moving to a fully invested position. While there are a number of risks out there for equity markets, we feel that The Federal Reserve remains the markets key driver and monetary policy remains very favorable towards financial markets.
This was articulated by Fed Chairman Jerome Powell at the Jackson Hole Economic Symposium, where he laid out a perceived dovish tone for monetary policy despite the pronunciation of hawkish comments from fellow Fed governors. He reiterated that although the central bank could begin reducing its asset purchases soon, this tapering should not be interpreted as a sign of imminent interest rate hikes. He went on to intimate that higher interest rates could be years away not months, and that they would remain data dependent. This was a signal to us at MCF that the Fed would remain financial market friendly and less prone to a policy mistake. This combined with continued positive economic data albeit at a slower pace, led us to becoming much more confident about the direction of equity markets. While yields on longer term bonds may rise, we feel they will do so gradually.
What are the risks to the equity markets? One risk is inflation remaining at persistently higher levels for a longer than expected period or rising further. In the month of July core CPI (Consumer price index ex-food and energy) saw its smallest uptick in four months and should continue to moderate. In large part if we look at commodity prices, whether it be oil, lumber, agriculture products and others, their ascent has paused or in some case like lumber have dropped dramatically. We expect that to continue to be the case in the coming months, how Covid-19 continues to impact supply chains is very difficult to quantify, thus we continue to monitor the commodities markets.
The one element which really concerns us is the $3.5 Trillion dollar spending package being proposed by the Biden Administration. With consumer confidence at decade lows as measured by University of Michigan gauge of consumer sentiment, anything that directly impacts the consumer such as higher taxes, or the possibility of the package raising consumer prices could really hurt the economic rebound. Higher corporate taxes and on capital would directly impact financial markets and may have unintended economic consequences causing the equity markets to correct much more than expected. At this time market strategists on Wall Street feel that any fiscal package would be reduced in size and taxes would be raised much less than called for. We also feel this is a strong possibility and potentially see no deal at all due to President Biden’s recent drop in approval ratings surrounding the Afghanistan pullout. Anything short of a dramatic increase in spending and taxes would be a welcome relief for equity markets and raise their prospects going forward.
To summarize we are the most positive we have been in months and go into year end and next year with renewed optimism.
If you have any questions, please contact us directly.
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The opinions expressed here reflect the judgement of the author(s) as of this date and are subject to change without notice. Information presented here is for informational purposes only and does not intend to make an offer, solicitation, or recommendation for the sale or purchase of any product, security, or investment strategy. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed here. The information being provided is strictly as a courtesy.
Wells Fargo Advisors, Angela Shin, “Monthly Market Commentary,” September 2, 2021. CNBC, Kate Dore, “Democrats float a tax on investments to help pay for $3.5 trillion budget plan,” September 7, 2021. CNBC, Jeff Cox, “Powell sees taper by the end of the year, but says there’s ‘much ground to cover’ before rate hikes,” August 27, 2021. Bloomberg, Simon Kennedy, “Goldman cuts U.S. growth forecast, warning of 'harder path' ahead for consumers than expected,” September 07, 2021.