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Windsor Perspective: Q3 2021

Windsor Perspective: Q3 2021

| July 07, 2021

Windsor Perspective: Q3 2021

In this edition of the Windsor Perspective, we review market performance for the second quarter of 2021. In addition, we touch on some of the key drivers of the market as well as some of the growing concerns. Lastly, we discuss our outlook for the remainder of the year.


Q2 of 2021 - Another Strong Quarter

What a difference a year makes! As we enter Q3 of 2021, the world’s economies have sprung back to life. As companies re-open and consumers begin to flood restaurants, stores and in-person live events once again, growth worldwide is accelerating. We are seeing this through multiple viewpoints – crowded restaurants, full planes, traffic, long lead times for many goods, and of course in accelerating financial metrics such as corporate earnings and worldwide GDP.

World GDP Growth 2020-2022

Source: Capital Group, International Monetary Fund, World Economic Outlook Database, April 2021

Driven by this strong economic reopening, both the fixed income and equity markets delivered another quarter of very good performance. However, it was not a linear path this quarter, as the quarter was truly broken up into three months. The quarter started out on a very positive footing with April delivering solid performance. May’s performance was relatively flat, highlighted by volatility. June, which started weak due to concerns coming out of the Federal Reserve meeting, quickly shook off those worries and took the market to new highs. Altogether, the S&P 500 was able to close at an all-time high, delivering a solid total return of 8.5%. This performance was mirrored by the fixed income markets, with the widely followed U.S. Aggregate Index delivering a total return of 1.5%.

Jobs, Inflation and Interest Rates

As the economy has reopened in the U.S., there have been three topics that continue to be a key focus for investors – jobs, inflation and interest rates. These three items are inherently intertwined and have both short- and long-term implications for the market. Job growth has seen a very nice recovery off the bottom as the economy has come back to life. However, we have not yet recovered all the jobs lost during the economic closure, despite the help wanted signs on nearly every store or restaurant you pass. There are various theories on why the employment numbers are not stronger, but the key takeaway is demand for employees is very strong across the country and this will ultimately drive employment higher and translate into continued solid GDP growth.

U.S. NFIB Firms With Few Or No Qualified Applicants

Source: Strategas, NFIB is the National Federation of Independent Business

As jobs comeback, one major lingering concern is inflation. There is no doubt we are seeing inflation everywhere we look – lumber, travel, house prices, gasoline, food, etc., all are seeing higher prices. However, the Federal Reserve (the Fed), who has oversight for controlling inflation, is confident that this inflation we are experiencing is mostly transitory and not permanent. Although there is good reason for concern about higher inflation longer-term, if you look at the details, the Fed could be correct in the short-term. It was always expected we would have higher inflation in 2021, so that is not a surprise. The focus has been on the level of inflation. But the level of inflation is not as important as the duration and composition of the inflation. If you look at the composition of inflation currently, it is being driven by supply chain shortages and economic reopening sensitive categories. As shown on the left side of chart below, used cars, hotels, rental car rates and airfare are all seeing dramatic jumps in inflation. This is being driven by the economy reopening, pent-up demand and supply chain disruption – all of which should self-correct. Compare that to the right side of the chart which is rent, healthcare, and owner equivalent rents, all of which continue to be subdued. For inflation to be sustainable, we would expect to see rents and items such as wage inflation (which is also subdued) at above normal levels, but as of now that is not the case.

Economic Re-Opening Sensitive Sectors Vs More Durable Inflation Categories

Source: Guggenheim Investments, Haver Analytics. OER stands for owners’ equivalent rent of primary residence

It appears that the driver of inflation is the world’s supply chains were not prepared for the rapid demand that would come from both companies and consumers with the re-opening of the economies. There is abundant evidence about component shortages impacting manufacturing. Many of the automobile manufacturers had to temporarily shut down production lines due to semiconductor shortages, impacting supply of new cars to the market and therefore driving up the prices of used cars. Another example was the lumber yards not being able to be brought up to full capacity fast enough to counter demand. Even housing prices, which have risen due to a shortage of newly constructed homes. These examples cut across nearly all facets of life, including a shortage of trucks to deliver these goods. However, these appear to be short-term issues that should correct themselves. Fortunately, we are already seeing evidence that this is taking place. Below are the price charts of lumber, corn and copper. Three very different commodities, all which saw dramatic price increases, but are now beginning to moderate.

Key Commodities Beginning to See Pricing Relief

Source: Bloomberg

In summary, it appears that inflation is being driven by supply chain issues. Following the breadcrumbs, there was strong demand generated by the economy reopening along with Fed stimulus which combined generated high demand for goods and services. However, a lack of capacity due to labor shortages and uneven market reopening caused a breakdown in the logistics supply chain. The net result is the Fed believes inflationary price increases, shortages and overall supply chain disruptions should be mostly transitory.

Another interesting way to look at inflation is in interest rates. Typically, the yield on the 10-year treasury bond is a good proxy for the longer-term direction of inflation. Earlier this year, inflation worries were front and center as the yield on the 10-year treasury bond quickly climbed to 1.7%. However, it has now retreated to 1.44% as of this writing. This is an indication from the bond markets that inflation, although spiking currently, is more transitory than sustainable.

U.S. 10-Year Treasury Yield (daily)

Source: Bloomberg

In addition, the Fed once again commented this week that they are going to remain accommodative for the foreseeable future with no need to raise interest rates.

Where Does the Market Go From Here?

The market has responded to the strong economic reopening, rising to new highs. Earnings growth at corporations continues to accelerate to the upside and strong demand is driving GDP higher. The Fed has indicated it is going to remain accommodative, and it appears supply chain issues are slowly being resolved. Hiring will continue and overall unemployment should continue to fall. From an economic standpoint, things remain positive. However, we are still concerned with where inflation will settle out and if it is indeed transitory. Also, there are still unknowns around additional stimulus from the government and what an infrastructure bill may mean for the markets. Likewise, potential tax increases for both corporations and individuals needs to be monitored. In addition, there are some signs that Covid could rear its head again as the Delta variant takes hold. This will have to be watched the next couple months for any impact it may have on the global economic recovery. In the meantime, with the market ending Q2 at all-time highs, we would not be surprised to see a market pullback at some point this year. However, we would not view that as an end to the market run, but more of an opportunity, as we very much remain cautiously optimistic going into the back half of the year.

As always, we will be seeking out opportunities for your overall financial plan based on the current economy and our outlook. Together, we will continue to tailor your plan to suit your unique financial objectives and a risk level you are comfortable with. Thank you for your confidence in our team and in Windsor Wealth Management.

If you would like to talk about any of the issues raised in this edition of Windsor Perspective, or any aspect of your financial plan, please contact us.

Dream boldly. Plan wisely.


Market Snapshot as of 6/30/2021