With the economy continuing its strong rebound markets remain near the highs, with most indices up +15-20% YTD. Nevertheless, the 3rd quarter brought with it some new uncertainties which have weighed on sentiment, such as the Delta variant, continued supply chain pressures, gridlock in DC, and changes in monetary policy. As a result, markets have mostly traded sideways for the last couple months as they await better clarity on these issues. These factors have contributed to a modest pullback in the last few weeks, with significant divergence in performance between sectors.
In particular, sentiment surrounding the Delta variant has seen quite a shift in the last month. Initially, markets feared a slowdown in growth due to rising cases. This contributed to cyclical sectors most linked to the rebound, such as commodities and travel, lagging behind technology names which reasserted their leadership. A slowdown in manufacturing and retail sales indicators, as well as weaker guidance from US companies, all reinforced this narrative. Bond yields, which serve as a proxy for growth expectations, declined significantly in this period which helped to further boost tech stocks.
However, in the last few weeks this dynamic has flipped the other way, as the Delta variant has turned out to be less disruptive than feared. While still elevated, COVID cases have started to decline and employment, a key metric for the Federal Reserve, has continued to improve. This all has coincided with supply chain pressures and labor tightness collectively putting pressure on the Fed to begin unwinding their accommodative monetary policy. While data show that these pressures are concentrated in a few categories, the Fed has nevertheless acknowledged increasing risks of overheating the economy and indicated an imminent tapering of bond purchases. This has caused an increase in bond yields in recent weeks, which in turn has hit tech stocks and driven a rotation back into cyclicals. Market indices have been pulled down modestly in recent weeks as a result, given their relatively high weighting to tech stocks. The political showdown happening in DC with regards to the debt limit and infrastructure package have further caused some investors to take some profits.
This tug-of-war in narratives has largely defined movements in the market all year. However, this back-and-forth dynamic has created windows of opportunity which we have taken advantage of. Improving economic fundamentals has served to lift all sectors, even as there has been some temporary divergences. Likewise, corporate earnings have continued to improve which in turn has helped to bring down valuations in the market. So while various factors could create some volatility in the short run, we remain optimistic looking forward on the basis of these fundamentals and continue to be on the watch for new opportunities to add value in portfolios.
As always, thank you for your continued trust and confidence in our firm. We wish you and your family the best and welcome any comments or questions you have.