3rd quarter market review and 4th quarter outlook

It’s time again to look back on the quarter that was and make some predictions for what the fourth quarter has in store to wrap up 2021.

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From Thrivent Asset Management, welcome to episode 17 of Advisor’s Market360. A podcast for you, the driven financial advisor.

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Before we get to our outlook for the fourth quarter of 2021, let’s rewind to the third quarter which offered a couple of interesting surprises. We tapped into Thrivent Asset Management’s team of experts to help break it down.

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The big headline was that inflation continued to surge as supply shortages lingered across a number of industries. Personal consumption expenditures or PCE price index, which is a key measure of inflation, was up 4.3% over the 12-month period through August 31. According to the Bureau of Economic Analysis, this was the highest rate in 30 years.

Excluding food (which increased 2.8% over the past 12 months) and energy (which surged 24.9% over the past 12 months), the PCE price index was up 3.6%. While leaders at the Federal Reserve, or Fed, had predicted earlier in the summer that inflation would begin to drop back to normal levels, supply shortages have continued to drive up prices for products and services.

Another story was the resilience of the manufacturing sector. Although manufacturers have struggled with long delays on delivery of raw materials, U.S. manufacturing activity continued to thrive, according to the Manufacturing Purchase Managers Index report. According to the report, the latest reading signaled one of the strongest rates of expansion since 1983. It was boosted by solid increases in production and new orders, as well as a slight rebound in employment levels.

In news from the stock market, after climbing about 20% through the first eight months of 2021, the S&P 500® index, tracking the average performance of 500 large cap stocks, pulled back in September, dropping 4.76% for the month.

And finally, oil prices continued to rise, with West Texas intermediate, a grade of crude oil used as a benchmark in oil pricing, climbing 9.53% in September.

Speaking of oil, let’s drill down…

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As mentioned earlier, U.S. stocks faltered. The S&P 500 Index was down 4.76% for the month of September. That being said, the S&P 500 Index was up just over half a percent for the 3rd quarter and up almost 16% through first nine months of 2021.

September was also a rough month for the NASDAQ Index, following more than 3300 companies listed in its stock exchange, which dropped 5.31% for the month. For the 3rd quarter, the NASDAQ Index was down about one third of a percent, but it was up just over 12% through the first three quarters of 2021.

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On the retail front, sales inched up 0.7% in August from the previous month, and 15% from a year ago, according to the Department of Commerce. Total sales for the three-month period of May through July were up 16.3% from the same period a year ago.

Auto sales were down 3.6% in August but up over 10% from a year earlier. Building material sales were up 0.9% for the month and up 6.3% from a year earlier. And with consumers returning to brick-and-mortar retailers, department store sales were up 2.4% for the month and 28.6% from a year earlier. Still many consumers continued to shop online, with sales moving up 5.3% for the month and 7.5% from a year earlier.

Sales at restaurants and bars were flat in August, but sales were up almost 32% from a year earlier when many businesses were closed to walk-in traffic due to the pandemic.

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When we look at the unemployment numbers, we see a mixed bag. In the week ending September 25, initial unemployment claims were up to 362,000 after dropping to just 310,000 claims for the week ending September 4. The rise in unemployment claims was attributed, in part, to the impact from Hurricane Ida, which may have caused people to delay filing for unemployment.

The U.S. economy added 235,000 new jobs in August, and the unemployment rate dropped from 5.4% to 5.2%.

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Turning to the sectors of the S&P 500 Index. The Energy sector was up 9.44% in September. But it was the only sector making gains. All other sectors were caught in the market downdraft, posting losses for the month.

But if we look at the 3rd quarter as a whole, Financials were up 2.74%, followed by Utilities, up 1.78%, and Communication Services, up 1.60%. Through the first nine months of 2021, Energy led all sectors, up 43.22%, followed by Financials, up 29.14%, and Real Estate, up 24.38%.

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And now, a lightening round of vital statistics from the third quarter:

Bond yields moved up in September on inflation fears, with the yield on 10-year U.S. Treasuries climbing to 1.53% at the September close.

Corporate earnings expectations continued to rise in the 3rd quarter, as the economy recovered. The 12-month advanced earnings per aggregate share projections for the S&P 500 Index moved up 6.24% in the 3rd quarter.

The forward price-to-earnings ratio of the S&P 500 Index declined slightly in the 3rd quarter, despite a slight increase in stock prices.

The Euro was down 2.27% versus the dollar in the 3rd quarter, and down 5.28% through the first three quarters of 2021. The dollar appreciated 0.53% versus the Yen in the 3rd quarter. For the year, the dollar has gained 8.07% versus the Yen.

Oil prices remained at a relatively high level. The price of West Texas Intermediate moved up 2.12% in the 3rd quarter and through the first nine months of 2021, the price of oil jumped over 54%. Gasoline prices have also moved up significantly this year, with a nearly 42% increase since the end of 2020.

Gold prices dipped slightly in the 3rd quarter, declining 0.82%. For the year, gold prices have dropped 7.29%.

And finally, after a solid run-up through the first half of 2021, international equities have dipped slightly in the 3rd quarter. The MSCI EAFE Index, which tracks developed-economy stocks in Europe, Asia, and Australia, dropped just over one percent in the 3rd quarter.

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With the third quarter behind us, what’s the market outlook for the last quarter of 2021? We asked Steve Lowe, CFA, Chief Investment Strategist, and he answered with a question of his own—are edgy markets seasonal, transitory, or something else?

As the final quarter of 2021 commences, markets are on edge, with inflation, supply chain issues, and monetary policy raising concerns. Are these edgy markets a precursor to more volatility and potential weakness? There are two key dimensions to our fourth quarter outlook.

Dimension one: Inflation, Fed policy and politics.

A key long-term support to the overall stock and bond markets has been Fed policy, which has not only pinned short-term rates at effectively 0% but has also provided for the purchase of massive quantities of bonds in the open market. This has kept long-term bond yields very low, and real (inflation-adjusted) yields decidedly negative. It has also provided much of the fuel for the stock market’s advance.

The Fed has indicated over many months that the significant rise in inflation is due predominantly to unusual supply bottlenecks caused by the COVID-19 pandemic. The Fed has characterized this dynamic as being transitory, and that inflation pressures will eventually recede back to its 2% target.

However, persistent inflation, and now wage pressures, are entering into the debate amongst key Fed officials. The Fed has indicated that it will likely begin winding down its asset purchase program this year. The effect of this tapering has been a concern for some time, although it should not be a surprise to the market given that it has been on investors’ radar for years.

Politics has also entered into Fed dynamics. First, two influential Fed bank presidents are resigning, partly due to the negative optics of personal market trading. It’s important to remember that Fed bank presidents are important in setting monetary policy, so the uncertainty of these vacancies is relevant.

Also of note, Fed Chair Jerome Powell’s term will conclude in early 2022, and political maneuvering is modestly diminishing the prospects for his reappointment. The market has embraced Powell’s leadership, so his departure would not be a welcome development.

In summary, although a modest change in policy is coming – and politics may increase uncertainty over Fed leadership – monetary support for the economy and for markets will continue.

Dimension two: The dynamics of supply and demand.

It’s Economics 101—supply and demand matter. Consumer demand has been incredibly resilient during the pandemic. And the labor market continues to be very tight. This situation is a double-edged sword for the economy. On one hand, income and wages are meaningfully increasing, which is bolstering demand for goods and services, particularly as the economy continues to reopen.

On the other hand, the pandemic and long demographic trends are hindering the supply of labor to such an extent that some businesses are being significantly impacted, hindering growth.

Meanwhile, the pandemic’s depressing effect on supply chains continues, leading to problematic shortages for a number of materials and goods. Geo-political issues, especially with respect to China, also have hindered the sourcing of supplies.

The consequence of this disequilibrium in supply and demand is rising prices. Up to now, rising prices have not been a major issue for corporate earnings, which have been bolstered by a major snap-back in sales. As sales growth moderates and cost pressures persist, corporate earnings, which have continued to surpass expectations, may be affected.

Third quarter corporate earnings results will be an important dynamic (as always) in the direction of the market. As this podcast went into production most companies’ results had not yet been released, but there have been hints that earnings in certain industries and companies may be affected by rising costs, which could lead to further market weakness.

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So, what should you be communicating to your clients about the coming months? According to Steve Lowe, our view of the markets has not changed significantly since the end of the 2nd quarter. However, risks have been rising along with market returns throughout the year.

Overall, the key supports to the economy and markets remain in place. However, costs pressures, monetary policy uncertainty, and fiscal policy politics represent new, and potentially negative dynamics, for investors to consider.

With interest rates remaining stubbornly at levels that are well below reported or expected inflation, fixed-income returns will continue to be lackluster at best. But rapidly rising interest rates and bond yields do not seem imminent.

We remain moderately overweight in equities. But in such a high-valuation market – with inflation signals flashing warning signs, Fed policy potentially in transition, and growth likely peaking – we continue to believe this is not a time for aggressive positioning.

Security selection, focusing on quality, durability, and solid fundamentals regardless of sector is important, particularly in a choppy, somewhat leaderless market environment.

Outside the U.S. equity market, the developed markets, particularly Asia (outside of China) and Europe, appear to be in a better position than the emerging markets. Emerging markets will remain challenged by the insinuation of the Chinese government in their economies, rising interest rates, a stronger dollar, and geo-political tensions.

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Thanks for listening to this episode of Advisor’s Market360. All episodes are available on Apple Podcasts, Spotify, and Google Podcasts. Learn more about us at thrivent funds dot com and find other items of interest to you, the driven financial advisor. Bye for now.

All information and representations herein are as of October 5, 2021, unless otherwise noted.

Any indexes discussed are unmanaged and do not reflect the typical costs of investing. Investors cannot invest directly in an index.

Past performance is not necessarily indicative of future results.

Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or a recommendation of any particular security, strategy or product.  Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.