Dear Clients and Friends:
The bull market took a breather in September, with the S&P 500 experiencing its first 5% pullback in over a year. Prior to the pullback, however, the S&P 500 made 53 new all-time highs before the end of August—a new record. We view the small pullback as healthy consolidation, as the market awaits further earnings and economic data.
Earnings have kept pace with the impressive growth in stock prices, as a record-breaking second quarter earnings season saw more than 86% of S&P 500 companies beat their consensus earnings estimates, the highest ever recorded and well above the 75% five-year average. S&P 500 earnings are now 26% above pre-COVID-19 levels based on the 2021 consensus estimate, helping to support stocks at current levels.
The Federal Reserve is expected to begin to taper its monthly bond purchases (currently $120 billion), but it appears to be committed to leaving interest rates low for the foreseeable future. The Fed likely won’t consider increasing rates until the employment picture improves further and will be leery of quickly removing stimulus if COVID-19 is still influencing consumer behavior. We believe this historic Fed accommodation will continue to be a tailwind for equities.
The Fed may be forced into action, however, should inflation continue to stay elevated. The Consumer Price Index (CPI) reached a level of 5.4% in September, as items such as energy prices, used cars, and airline costs have driven prices up dramatically. The CPI numbers will continue to have upward pressure as housing prices can often take 6-12 months to be fully reflected in inflation figures. The Fed has consistently stated that should inflation become problematic for an extended period, they will be forced to raise interest rates – but the Fed has maintained its calm up to this point.
Other concerns remain, even as the market hovers near all-time highs. Supply chain disruptions continue to drive higher input prices in select industries. There are geopolitical concerns, including the future of Afghanistan and China’s regulatory crackdowns. The current negotiations in Congress surrounding a $2T reconciliation package have investors wondering whether higher taxes are forthcoming. However, leading economic indicators point to continued expansion which should allow markets to withstand bouts of volatility that may result.
Looking ahead to the final three months of the year, we continue to view alternative assets such as real estate, private equity, and private credit as important pieces for portfolios in the face of reduced yields. While bond yields have dropped to historical lows, higher income can be found amongst private investments. Bonds still play an important role in reducing volatility for a portfolio, but alternatives are a key source to replace reduced income.
We hope each of you enjoy the upcoming holiday season, and as always, please feel free to reach out should you have any questions regarding your portfolio.
Sincerely,Gallacher Investment Committee