September 2021 | Equity Commentary
Published on October 6th, 2021
September was a choppy month for stocks and bonds, as macroeconomic headwinds converged on the U.S. and global economy. Among the issues surfacing in September were consumer sentiment dipping on Delta concerns, the Federal Reserve giving clearer indication of ‘tapering’ plans later in the year, a debt ceiling standoff, and China dealing a range of uncertainties spanning real estate, energy, manufacturing, and state-driven economic reforms. The S&P 500 suffered its worst month since March 2020, sliding -4.7% in September. U.S. Treasuries also sold off during the month, likely in anticipation of upward pressure on interest rates tied to Federal Reserve tapering and longer-than-expected inflation pressures.
The surge of the highly contagious Delta variant seemed to temporarily hit the ‘pause’ button on the post-pandemic growth boom. Consumers trimmed spending on hospitality services and travel in July, and supply constraints—tied to worker and component shortages, reduced factory capacity in Asia, and ballooning shipping costs and delays—led many economists to mark down GDP growth estimates for Q3. Forecasting firm IHS Markit lowered their Q3 GDP forecast from 7.8% in July to 3.6% by late September.1
The Delta-induced blip in economic activity appears to be fleeting, however, and consumers appear to remain in a strong financial position. Households have a record $142 trillion in net worth, wages are on the rise, and there are still roughly as many job openings as there are unemployed Americans.2 Consumers seem to be paring spending on big ticket items, like vehicles and furniture, but they are spending more in areas like retail and services. In a sign that spending, and growth remain in an upward trend, personal outlays on goods and services rose 0.8% in August compared to July, according to the Commerce Department.
Downward revisions to economic growth forecasts in Q3 have given way to rising forecasts for economic growth in Q4 2021 and beyond. The belief is that aggregate demand and future growth were not lost as a result of the Delta surge, but merely delayed by a few months. The Federal Reserve raised its full-year GDP growth forecast for 2022 to 3.8% in September, up from 3.3% in their June forecast.3
At a two-day meeting held in September, the Federal Reserve did not make any changes to policy but did set the stage to begin ‘tapering’ the quantitative easing program, potentially as soon as the November 2-3 meeting. Gradually trimming the $120 billion in monthly purchases is often framed as monetary tightening, which could have a deleterious effect on the stock market. But the reality will likely look much different, in our view. For one, the Federal Reserve clearly telegraphs plans well in advance, which greatly reduces the possibility of a negative surprise. Second, an underappreciated result of reducing bond purchases is that it places upward pressure on longer duration Treasury bond yields, which will arguably steepen the yield curve over the next several months. A steepening yield curve is generally a positive leading indicator for economic activity.
We believe another temporary macro headwind in September was the risk of a government shutdown that featured prominently in the headlines. Congress has since passed a small spending bill to keep the government open until at least early December. The narrow spending bill may have received bipartisan support (254 to 175 in the House, and 65 to 35 in the Senate), because it included funding for resettlement of Afghan refugees and disaster recovery funds for hurricane and wildfire damage here in the U.S.
The more consequential debt ceiling issue remains unresolved. Treasury Secretary Janet Yellen has warned that failing to raise the debt ceiling would mean ‘running out of money’ by October 18. We expect Congress to raise the debt ceiling and thereby avoid a default event. In our view, brinksmanship is likely to bring the issue to the 11th hour, however, with the potential to inject short-term volatility into the capital markets. The Democratic Party can resolve the issue unilaterally through the reconciliation process, which seems the most likely route, given Republican opposition in the closely divided Senate.
Finally, there is China, which has arguably been the biggest driver of September volatility. China’s headwinds appear to stem from multiple sources: a slowing economy, heavy-handed government intervention across a variety of sectors, an energy crunch, and the looming default of property developer Evergrande, the country’s largest high-yield issuer. The Chinese government has been tightening the spigot and reining-in debt and lending practices, which has stunted Evergrande’s cash flow and has the company at the brink of bankruptcy. 42% of Evergrande’s $89 billion in outstanding debt is reportedly due within the next year.4
The risk is sizable for China, but we do not expect the U.S. capital markets to suffer significant contagion from China for two reasons. First, we expect Beijing to act in order to prevent an Evergrande default from cascading into a financial crisis, as the state has the means and the political will to do so. 2022 is a key year for President Xi Jinping, when China hosts its twice-per-decade Communist Party congress and will decide whether to extend his leadership. Second, we are not seeing signs of the contagion in the usual channels: commodity prices remain high, and spreads remain tight in the U.S. high yield market, where the issuance window is wide open. In 2016, when turbulence in China impacted U.S. markets, commodity prices declined, and U.S. high yield spreads materially widened. We are not seeing these indicators today.