Market Commentary

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The December FOMC statement and SEP projections suggest that the Fed will be done with taper by end of March 2022. To get a sense of how the taper of QE4 may affect markets, we look at how various markets traded (i) in the three months leading up to the completion of taper, and (ii) the six-months following the end of taper. We follow the timeline provided by the New York Fed here and look at the returns of the S&P 500, U.S. Treasuries, Commodities, Gold, and the Dollar. We caution that our sample size of three is extremely small and that the results should be taken with a large pinch of salt. Nevertheless, we provided the data for illustrative purposes to get a sense of what one might expect in the 9 months ahead.

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CPI inflation remains elevated despite coming off the summer peak. Inflation has continued to rise at am annualized rate of 3-4% over August and September, despite a slowdown in jobs growth. Total nonfarm payrolls have increased at an average pace of +561k per month this year, though we’ve seen a significant slowdown over the past two months at  +366k in August and just +194k in September.

At the same time, port congestions have been on the rise and the price of shipping has increased dramatically this year. On October 13, President Biden announced that the Port of Los Angeles and the Port of Long Beach (which process ~40% of U.S. imports) will begin operating 24 hours a day, 7 days a week, to address these concerns.

Given the attention and focus on the transience/permanence of inflation, this month we dive into the numbers to see drivers behind this dynamic and its potential impact on the outlook for inflation.

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The Fed’s balance sheet has nearly doubled in size to $4 trillion since the beginning of the COVID-19 pandemic and money supply has risen by a commensurate amount. As a result of this bond-buying and a further commitment to keep rates near zero, yields declined significantly in the early months of the pandemic with the 10-year yield dropping as low as 0.52% at its trough in July 2020.

But this move quickly reversed in 2021, and yields retraced almost the entirety of the post-pandemic move back towards the levels of Q4 2019 and Q1 2020. 

This was not to last. Since their Q1 2021 peak, yields reversed course again, falling by about -0.41%. This has happened despite macroeconomic indicators that would suggest investors would prefer riskier assets. Falling yields caught market participants off-guard, leaving many scratching their head. This month we look at this conundrum to see what it may be telling us about the outlook for the economy.

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“If you wish to see the truth, then hold no opinions for, or against, anything” – Third Chinese Patriarch of Zen

The COVID-19 market crash and subsequent recovery has been atypical of previous recessions. Government lockdown brought economic activity to an abrupt standstill, but reopening as well as the fiscal and monetary response were just as decisive. In just a little over a year from lockdown, economic activity in the U.S. is expected to have exceeded pre-pandemic levels this past June and equity markets are well above pre-pandemic highs. This V-shaped recovery has the market running at a torrid +45% per annum rate since March 2020, with the S&P 500 up a robust +65% from its March 2020 close. Despite elevated unemployment in the U.S., many are warning of speculative “bubbles” based on the rapid rise of stretched valuations.

While the current market rally is impressive on its face, this month we look at historical trough-to-peak rallies to see how the current market compares with previous cycles.

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May was generally quiet, and economic data continued to suggest strong momentum. In Europe, the pace of vaccinations caught up quickly and the heightened COVID restrictions originally imposed in April were relaxed. In the U.S., April CPI (released in May) showed a 4.2% year over year increase in CPI inflation, the fastest pace since 2008, though the Fed continues to hold that the rise is temporary and attributable to base effects from depressed readings a year ago due to COVID-19. With central banks and market participants debating whether recent inflation will prove transitory or persistent, this month we examine the performance of equities under various inflation regimes.

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April was a relatively quiet month. The Fed reiterated its commitment to continue bond purchases and hold rates steady for “some time” until “substantial further progress” is evidenced in the economic data. President Biden released additional details on his $2 trillion infrastructure spending plan and made a strong push in his speech to Congress last week, focusing on maintaining U.S. competitiveness in the global economy and jobs.

During his April speech before a joint session of Congress, President Biden proposed raising the maximum capital gains tax rate from 20% to 39.6%. While it is likely that any hike will be less than proposed, some form of increase is likely to be implemented for fiscal year 2022. This month, we look at historical changes to the capital gains tax rate and its impact on equity market returns.

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The speed and magnitude with which fiscal stimulus was implemented in response to the COVID-19 pandemic was unprecedented. As shown in the chart below, Q1 2020 saw the year-over-year change in fiscal outlays increase 160% from the year prior (an 8 standard deviation increase) boosted by a $2.2 trillion stimulus package. Q4 2020 (not included in the chart) saw an additional $900 billion stimulus, followed by an additional $1.9 trillion passed into law last month. Attention now turns toward President Biden’s $2 trillion infrastructure and jobs plan and how that wave of spending may impact financial markets when it hits.

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