No Ace Left in the Hole
One of the many great lyrics Garth Brooks has given us is, “All my cards are on the table, with no ace left in the hole,” and it’s a perfect representation of my feelings about the fourth quarter. That may sound like a negative take, but I want to be clear—even in my worst-case scenario we’d still end the year up almost 11% on the S&P 500. I’m simply finding it more and more difficult to expect any kind of meaningful rally before the end of the year. Here’s why…
Weight of the Evidence Is Heavy
Coming into fall, many expected volatility to ensue. And it has—we finally saw a 5% correction on the S&P at the end of September. While we’ve recovered slightly, the index is still down roughly 4% since the end of August.
If history is a guide, particularly if last fall is a guide, we could expect a more positive November and December. But as I made a list of the negatives, they handily outweighed the positives into year-end.
For starters, GDP growth has been revised downward or pushed out further into the future by multiple sources. Projections are still well above pre-pandemic levels, but they’re lower than originally expected for 2021 due to factors like supply chain issues and labor shortages. Taken together, those three forces—lower GDP growth, supply squeezes, and labor weakness—pave a difficult path for a year-end rally.
Trained for a Marathon or a Sprint?
The next factor I worry about is the stamina of consumers and businesses to pay for or pass-through some of these issues. Yesterday’s CPI reading (5.4% year-over-year) marked the sixth month in a row of inflation above 4%. Studies have shown that when inflation is persistently above 4%, it starts to pressure stock performance. The question becomes: how much longer can companies absorb inflationary costs and labor shortages (which in turn drive higher labor costs) before they become a real drag on earnings per share?
Likewise, at what point will consumers hold up their hands and say “no more” to price increases? We’ve predicated economic strength on pent-up demand and the money still sitting in savings waiting to be spent. What if they don’t spend it because the stuff just plain costs too much?
Politics and Policy
Moreover, one of the catalysts for the strong rally into year-end last year was the fact that the Presidential election was over (okay, over-ish) and removed a big uncertainty from our plate. Shortly thereafter, positive vaccine news came out and removed another big uncertainty. No similar kind of uncertainty-removing event is on the docket this year.
Conversely, the government debt ceiling and reconciliation debate now looks like it could carry into December. Add to that the possibility of Fed tapering before the end of the year and we’ve still got some mud to trudge through.
The Elusive Ace
These headwinds and the idea that there’s “no ace left in the hole” lead me to believe that the volatility is not over yet. They also lead me to believe that it would require various positive developments to take us back above the most recent highs from Sept. 2 (S&P 500 level 4,537). Meaning, we may not see new highs until 2022 when some of these headwinds subside. But to my very first point—even if we fell down to the 200-day moving average on the S&P and stayed there for the rest of the year…we’d still end with a calendar year return of almost 11%. Not too shabby. It just might have all been produced in the first three quarters.
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