“Pessimism and bearishness never get you in the game, while untamed optimism
means that at some point, you’ll have a serious setback. The cautiously optimistic investor asks both, “What could go wrong?” and “What could go right?”
– John Mauldin (09/24/2021 Thoughts from the Frontline Newsletter)
After seven straight months of gains the stock market took a breather. Normally a more volatile time for stocks, September 2021 was no exception to the rule with all the major stock market indexes we follow printing losses for the month. The two winning asset classes were the CRB Commodity Index with a gain of 6.41% and the US Dollar with a 1.75% increase in value vs. a basket of currencies. The bond index we follow lost 0.86% for the month.
All data as of 07/01/2021, Source: Wells Fargo Investment Institute. [Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.]
The quote from economist John Mauldin is a reminder to us all that we always need to be balancing out the probable and the possible good and bad scenarios when thinking about the stock market. We have been of the opinion that the stock market is in a secular bull market which will continue for a number of years. We believe that the upward trajectory will continue on until we see a secular shift toward a higher interest rates environment. Currently interest rates are near all-time low levels after a 40+ year move down. We may or may not be close to a market-changing inflection point.
In the short-term, the stock market doesn’t always trend higher during a bull market. Corrections happen. In fact, corrections happen on a regular basis. Chart #1 shows the annual returns for the S&P 500 dating back to 1980 with the largest intra-year decline. The average decline is 14.3% and in 2020 it was 34%. So far in 2021 the largest “correction” has been 5%.
Chart #1: Source: JPMorgan Guide to the Markets
Looking at the stock market – specifically the S&P 500 – we see the makings of a “real” correction coming our way. On September 20th the index broke below it’s 50 day moving average (50DMA). This is significant in that the 50DMA has been acting as support all year. It closed the month just below it’s 100 day moving average (100DMA). With everything going on in the world today we are not surprised that the stock market has reacted in this manner.
The market is telling us it is time for a correction. We are looking at somewhere around the 200 day moving average (200DMA) level of 4134 and the May lows of 4060 as our downside target. Those numbers represent a 9-10% drawdown from the all-time high realized on September 2. Would this scenario be a bit painful? Sure. Would it be unusual? Historically, not at all.
There is much going on away from the stock market that can have an effect on how equity markets perform. Commodities have been robust this year with the CRB Commodities Index posting a 36% return so far in 2021. This is important for a number of reasons. Many commodities producers trade on the public markets along with supplying basic materials to producers of everything from foodstuff to furniture. These companies could see a rise in earnings with higher pricing, but also become an additional cost for the companies they supply goods to, who then pass along some or all of the additional expense to their customers.
Bond yields, unlike commodities, entered September in a down trend. That trend changed mid-month as the 10-year Treasury yield ended the month at 1.52%. The rise in interest rates has occurred as the technology sector has come under pressure. Coincidence? We don’t think so. “Growth” companies tend to be valued more heavily on expected future earnings expectations vs. current earnings. In a higher interest rate environment those future earnings are worth less. A continuation of the trend is likely to add pressure to the more growth-oriented sectors and stocks.
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Chart #3: Source: www.stockcharts.com
Much like bonds, the US Dollar had a very strong September, breaking above the 2021 trading range with a move above 94. We see a move to higher levels to be the probable scenario in the coming months. A strengthening US dollar puts earnings pressure on large, multinational corporations. Overseas earnings get have to be converted back into dollar terms for reporting. A stronger dollar reduces earnings as less dollars are received when the conversion happens. With the break above resistance at 93.5 we expect to see continued dollar strength.
Inflation has become a hot topic among our clients as well as the chattering class on tv over the past few months. Prices are up for a variety of reasons, and there is some disagreement as to how prevalent it will be in the coming years. One camp’s viewpoint is that the current inflation is transitory, lasting only as long as supply chains are not functioning as they should. On the other side of the argument are those who see this to be the beginning of a years long trend of continuing higher prices. In the middle of the argument is some data suggesting broader inflation pressures are beginning to show.
There are three possibilities – 1970s-style stagflation, the Fed’s sweet spot of 2% inflation, and 1990s-like slightly above target inflation that sticks for a longer period of time. Here at Magellan Financial we see the third option as the most likely scenario. For two reasons.
First, supply chain disruptions are not going away anytime soon. The issue isn’t just production but shipping as well. Ports continued to be backed up and the cost of shipping is high. New plants are being built for things like computer chips. Great news, for sure, but these are projects that take years to complete.
The other issue is demand is not waning. Automobiles are a great example of this. Car lots have slim inventory as the salespeople inside are talking about when you can expect to get a car, not having you walk off the lot with one today. As it is a sellers’ market, don’t expect to get a great deal on a car or 0% financing. Moreover, this situation will persist until the automakers can make enough vehicles to meet the current demand AND restock the dealerships with inventory. Just like the production facilities, this is a process that will take years, not months.
American Retirement Savings News
Social Security could get biggest cost-of-living increase in 40 years – Over the past decade the average COLA has been a paltry 1.4%. Due to the recent spike in inflation the Senior Citizen League estimates a rise of 6.0-6.1% in next year’s benefit will be announced next month by the Social Security Administration. This would be the largest benefit increase since 1982.
Can young people still count on Social Security? – The short answer is YES. With nearly 1/3 of all elderly Americans exclusively reliant on Social Security to fund retirement and a new report showing the fund being depleted by 2033 this sounds like an impossibility. Yet even in 2033 there will be enough payroll taxes coming in to pay 75% of the benefits due and a few simple fixes that can get the program back on solid ground. Rising the official retirement age, taking the cap off the amount of income eligible for Social Security taxes and changes to the cost-of living increases will all likely be discussed. Even without changes the new report shows 74% coverage out to 2095.
Final Thoughts
The market of stocks we refer to as the stock market is always a balancing act of factors that can be either positive, negative, or both on its components. There are always many things that can go wrong along with many things that can go right for the stock market. Certainly, it is easy to assume bad things coming off a poor month performance. Yet there’s a lot of good going on right now.
The economy has taken a hit with the Delta surge but is still strong. Interest rates, while starting to trend higher, that is a trend off of historical low levels. Corporate earnings are not expected to be as robust in 2022 as they were this year, but are still projected to be solidly higher (and at record levels). A lot there that can go wrong … but a lot that can go right.
Pessimism and bearishness will never get you in the game. We do see a “real” correction in the stock market in the short-term but remain bullish on the stock market for the long term.
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Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
All investing involves risks including the possible loss of principal invested. Past performance is not a guarantee of future results.
Index returns are not fund returns. An index is unmanaged and not available for investment.
Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 “blue-chip” industrial U.S. stocks.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
S&P Midcap 400 Index: The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between the S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
S&P Small-Cap 600 Index: The S&P SmallCap 600 Index consists of 600 domestic stocks chosen for market size, liquidity (bid-asked spread, ownership, share turnover and number of no trade days) and industry group representation. It is a market value-weighted index (stock price times the number of shares outstanding), with each stock’s weight in the index proportionate to its market value.
MSCI World Index: The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.
MSCI EAFE® Index: The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
Bloomberg Barclays U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market.
Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents
Technical analysis is only one form of analysis. Investors should also consider the merits of Fundamental and Quantitative analysis when making investment decision. Technical analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the future.
Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.
Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the bond’s price. Credit risk is the risk that the issuer will default on payments of interest and/or principal. The risk is heightened in lower rate bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
Investing in commodities is not suitable for all investors. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.
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Robert I Cahill, Managing Partner Rob.Cahill@wfafinet.com
Jeffrey T. Bogert, Partner
Jonathan D. Soden, Partner Jon.Soden@wfafinet.com
Robert Sweeney, Financial Advisor Bob.Sweeney@wfafinet.com
Jay Knight, Associate Financial Advisor Jay.Knight@wfafinet.com