• Volatile September. US equities notched a small positive return in Q3.  Strong earnings had lifted stocks in their run up through August, but jitters over growth, and growing inflation concerns, caused US equities to retrace some steps in September.  September has historically tended to be the weakest month of the year, and this year it marked the first decline of 5% or more from market tops since October 2020.

• Moderating Economy. The US economy grew rapidly in the spring, and has now exceeded pre-pandemic levels after the short but deep recession last year.  Economic data remain strong, but with the catalysts driving the burst of economic growth–rounds of government relief and a surge in consumer spending with the reopening of businesses–fading, early indicators suggest the recovery may be slowing down from the early rapid pace, and we are heading into a more moderate phase of expansion.

• Supply Chain Woes. Manufacturing slowed into the back half of the quarter, reflecting the ongoing challenges to the supply chain and materials and labor shortages.  Supply chains are overloaded by a sudden surge in consumer demand, combined with parts shortages, and complications are lasting longer than anticipated as we continue to battle the surge in the Delta variant.

• Covid Cases. In order for supply tightness to begin easing, the situation surrounding Covid needs to get better first.  It is worth noting that supply constraints were actually showing signs of improvement in late spring, but the rapid spread of the Delta variant around the same time quickly put a halt to progress.  Encouragingly, we are seeing a clear downtrend in the recent number of new cases and deaths in the US, consistent with past patterns of surges and declines.

• Fed Tapering. As inflationary pressures continue to weigh on the economy, statements from the Fed meeting reflected that the Committee is close to announcing a tapering of the bond purchases that have been in place since the early days of the pandemic.  The Federal Reserve will be under intense scrutiny as it moves toward tighter monetary policy, and walking the fine line between keeping the economy recovery on track and controlling inflation.

• Political Standoff. The standoff in Washington over a variety of issues continue, with the debt ceiling at the top of investors’ minds.  The debt ceiling has, in the past, spurred contentious and prolonged debate about fiscal responsibility and the growing national debt.  Failing to increase the debt limit would have catastrophic economic consequences.  History suggests this is unlikely.  Congress has always acted to forestall default, though often at the last possible minute.

• Market Outlook. Although the reopening story is far more nuanced than earlier in the year, we remain constructive on a longer-term view of the recovery.  In the short term, we think there is elevated risk for some additional market weakness stemming from lost sales and margin pressures, and we are looking to the upcoming earnings reporting season for clues to investor sentiment.

Christopher Lai

Senior Portfolio Manager

10/14/2021