The seasonal market weakness that has historically dogged investors in September put a damper on the third quarter rally. As we head into the final quarter of the year, there are a mounting number of headwinds (or narratives) threatening to slow the recovery from the pandemic recession. Stagflation, delta variant, energy shortages, US debt crisis, Evergrande crisis, Fed tightening … to name a few. We addressed some of these concerns directly in our last Markets in Motion… but now we want to focus on the bigger picture. Faced with this catalogue of woes, the stock market setbacks in September are hardly surprising. But with major indices only ~5% off their September all-time highs, is the worst still to come?
While no one can rule out more downside in the days ahead, we believe most risks are either already discounted, exaggerated, transient or irrelevant to equity prices. And broadly speaking (entire NYSE), while it may not feel like it, most stocks have gone nowhere for the past 5 months. (Chart 1).
And as we’ve highlighted in the past with other market narratives, the business cycle is by far the most important driver of equity returns over intermediate-term horizons. So where are we in the business cycle?
We believe global growth has peaked, but at very high levels. Progress on the vaccination campaign, along with continued accommodative monetary and fiscal policies, should keep growth above trend and recession risks at bay for the foreseeable future. This means there is a strong chance stocks and other risk assets continue to make new highs as recession risks remain low. (Chart 2)
Therefore, our portfolios remain overweight stocks. As previously noted, the risk-reward profile for equities is not as appealing as it was last year, but the TINA theme (There is no alternative to equities) will continue to resonate with investors. After all, money flows to where its treated best and after consolidation, stocks are breaking out against bonds. (Chart 3). We believe this rotation from bonds to stocks is just beginning to play out after a decade of flows into bonds. (Chart 4).
This month, we added to risk assets after de-risking before September. We initiated a position in Global natural resource equities to take advantage of a cyclical upswing. Additionally, we initiated a position in local currency emerging market bonds where we see attractive yields and a mean reversion opportunity.
Finally, know that all our Strategies will adapt to fundamental or rules-based, not emotional influences. We seek opportunities for solid risk adjusted returns and to preserve capital in asset market downturns.
Recent Portfolio Changes
We exited our position in Intermediate Treasuries and reduced exposure in Gold to initiate positions in global resource equities and local currency emerging market bonds. We trimmed tactical risk-off positions to take advantage of a rotation back to cyclical assets.
1 Information as of 09/21/2021. Individual account allocations may differ slightly from model allocations.
John A. Forlines III
Chief Investment Officer
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