August 2021 Market Commentary
September 13, 2021
Markets continued to follow the path of least resistance higher aided by continued strong economic activity, strong corporate earnings, and dovish Fed commentary. That was enough to offset concerns about the rapid spread of the coronavirus Delta variant and any attendant economic impact. For the month, large caps (S&P 500) returned 3.0%, while small caps (Russell 2000) returned 2.2%. International markets also generated positive returns with developed (MSCI EAFE) and emerging (MSCI EM) markets returning 1.8% and 2.6%, respectively.
US economic activity remained strong despite challenges presented by labor shortages, rising input costs, and global supply chains. Second quarter corporate earnings, reported in July and August saw consolidated S&P 500 earnings increase 95% from 2Q20, driven by a 25% increase in revenues. The July employment report, released in early August, indicated that employers added 943k new jobs in the month, helping lower the unemployment rate from 5.9% to 5.4%. Through July, the economy had recovered 15.8M of the 21.4M jobs lost in March and April 2020. After several months of sharp increases, inflation showed signs of moderating. Monthly increases in both the consumer price index (CPI) and the Fed’s preferred measure of inflation, core personal consumption expenditures (PCE), decelerated from the prior month. On a year-over-year basis, both measures increased at the same pace they had the previous month, suggesting a potential leveling off. Further evidence that price pressures may be subsiding was provided by industry group ISM, which reported that prices paid by manufacturers in August fell to their lowest level since December 2020. All of these developments were consistent with the Fed’s view that the current bout of inflation will prove to be transitory.
Concerns about the coronavirus Delta variant intensified as new cases surged to levels last seen in January when vaccines were first starting to be distributed. The surge accelerated during the month, just as schools were starting a new school year and business were increasingly bringing workers back to the office. That led to renewed concerns about how smoothly the economy can run if those plans are derailed. While new nation-wide restrictions are highly unlikely, consumers could nonetheless alter their behaviors, thus impacting economic activity. Such concerns appeared to be validated by a sharp drop in consumer sentiment, the seventh largest monthly decline on record, and consumer confidence falling to a six-month low. Deteriorating consumer confidence could presage a nearterm pullback in spending.
In late August, Fed Chair Jay Powell delivered his highly anticipated Jackson Hole speech. In it, he addressed a number of topics including labor markets, inflation, and the omnipresent question of when the Fed expects to begin tapering its asset purchases. Regarding the labor market, Powell noted that it has “brightened considerably” in recent months and that “the prospects are good for continued progress toward maximum employment.” On the topic of inflation, Powell acknowledged current levels are “a cause for concern” before reiterating that “these elevated readings are likely to prove temporary.”
Finally, with respect to tapering, Powell suggested it could begin later this year, without providing a firm date. Importantly, Powell noted that tapering “will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test.” In other words, rates may well remain at current levels for an extended period of time following the conclusion of the Fed’s asset purchase program. Expectations are that the Fed will formally announce its tapering plans following its September or November meeting. However, given the disappointing August employment report showing only 235K new jobs were added, the Fed may choose to wait until November in order to see how other economic data develops in the coming months.
Unlike equities, bond markets fell slightly in August, with the Bloomberg Aggregate Bond Index, the broadest measure of the US bond market, down 0.2%. Within fixed income, high yield was the only sector to generate positive returns, up 0.6%, demonstrating its higher correlation to equity markets. Treasuries, investment-grade corporates, and munis, fell 0.2%, 0.2%, and 0.4%, respectively. The losses were due in part to an increase in yields, snapping a four-month streak of declines in the 10-Year Treasury yield. The catalyst for the rise was the July employment report, released in early August, which detailed a steep increase in job creation, a decline in the unemployment rate, and an uptick in labor force participation. Prior to the report, the 10-Year yield was at a month low of 1.17%, but climbed to 1.30% following the report’s releases. For the rest of the month, yields remained in a tight range, between 1.24% and 1.36%, before ending at 1.30%. Fluctuations in yields during the month were influenced by moderating, but still high, inflationary data, as well as projections regarding the impact on growth, both here and abroad, from the spread of the coronavirus Delta variant.
Municipal bond yields also rose in August as muni bonds prices pulled back from record high levels. Any decision by the Fed to taper its asset purchases should put additional upward pressure on both muni and Treasury yields. Municipal bond prices continue to be helped by consistently strong demand and a lack of supply, keeping any price declines modest, as they were in August. Demand is likely being helped by the proposed $3.5T budget and $1.2T infrastructure bill, with buyers possibly looking for tax-advantaged product in response to possible tax increases needed to fund the proposals.