Market Commentary – October 2021

“Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man” Ronald Reagan    While most everyone knows inflation means higher prices for goods and services some seem oblivious to the fact it erodes portfolio values and more so portfolios heavily focused on fixed income investments.  Inflation is literally a tax put in place without legislation that erodes value and amounts to asset confiscation.  The question investors should now ponder is this current inflationary environment we find ourselves in transitory or long-term?

There is no denying over the last 18 months our government has created the greatest liquidity event ever by conjuring up and distributing dollars to a large percentage of the individuals, municipalities and states that make up this great country.  There is no doubt the liquidity sloshing around our financial system has helped inflate asset prices to their current values.

Most financial asset classes finished within shouting distance from where they started the quarter.  In the month of September many equity indices give up most of their prior two-month gains.  The broad S&P 500 retreated -4.6% in September and dragged the Q3 return to a disappointing .7%.  For the first nine months of the year the S&P 500 is up 15.9%.  Over the same nine-month period U.S. small cap stocks have returned 12.4% while foreign equities as measured by MSCI have provided a nine month return of 5.9%.  Foreign markets have lagged the U.S. broad equity market significantly over the last one, three, five and ten years.

For the trailing ten years the S&P 500 has annualized a return of 16.6% versus 7.5% for the MSCI foreign index.  Many institutional managers have 30% to 40% of their client’s equities in foreign stocks.  Managers who have been much less aggressive in foreign investments have helped their clients outperform.  How much has your foreign exposure been the last five or ten years?

Bond yields continue to cause investors to yawn as the range of yields on treasury maturities from two year to ten years go from .28% to 1.52% respectively.  WOW   The aggregate bond index has lost -1.5% thus far in 2021.  With inflation running conservatively at 4% bond investors are stuck in quicksand with little chance to keep pace with inflation. We guess it is a good thing some government inflation indices exclude food and gas because apparently it is not only Hollywood but also the rest of America that does not eat or drive vehicles requiring gasoline.

One of the few positive places to be in the bond market this year, excluding non-investment rated bonds, has been treasury inflation protected securities (TIPS).  Their total return over the first nine months has outperformed the bond index by more than 5%.  Another bright spot in the third quarter was commodities which generally posted strong gains and continued a year-to-date trend.  A commodity basket of exposure to oil and natural gas along with broad agriculture and industrial metals did very well.  Are you seeing a trend to inflation hedging assets here?

Looking ahead our politicians have kicked the debt ceiling can to December.  Hard to believe much gets done ahead of their race to depart Washington D.C. for the holidays.  Given the global supply chain challenges, potential for higher inflation, labor shortages and China’s increasing unpredictability caution is warranted.