Football is back, the leaves are changing, and pumpkin spice lattes have found their way into your local coffee shop. Our Director of Investments, Daniel Dusina summarizes the three key themes we are watching this quarter.
From an economic perspective, the United States has proved resilient. After GDP growth of an annualized 6.5% in the second quarter, the U.S. economy is now larger than it was before the pandemic. Strong household balance sheets have fueled robust consumer spending, a trend we highlighted last quarter and one that we see persisting. There is; however, a formidable chink in the economy’s armor: it is nearly impossible to hire individuals.
When viewing rolling 10-year equity returns, very few periods in history would have yielded a negative result. It appears that investors are set up to be more favorably rewarded relative to the level of risk involved. Gain insight into equity markets in this second part of our Q4 2021 Economic Outlook.
While our outlook for the economy and financial markets is constructive, you may recall that our Q3 Quarterly Edge pointed out the tendency for the second year of a secular bull market to pose bumps in the road. We have digested elements from the last quarter that should be reassuring to investors, but as with any market environment, risks appear on the horizon as well. A summary of potential catalysts, positive and negative, are outlined in this video.
The U.S. economy has proved resilient after the bumps in the road presented by the COVID-19 pandemic. Data points to continued growth through the end of the year, albeit with lower intensity than has been seen through the first three quarters of 2021. The employment picture remains the laggard, as a stubbornly low participation rate could lead to continued upward pressure on wages. Small businesses are feeling the pain given the lack of available labor, a trend that we hope to see moderate over the next six months as virus fears moderate and excess unemployment benefits are withdrawn.
While the fixed income market poses unique challenges via ultra-low interest rates and deteriorated purchasing power, equities appear ripe for investment today. Earnings growth at the company level has outpaced price appreciation, which has led to multiple contraction and thus more attractive valuations on a price-to-earnings basis. Further, the Equity Risk Premium, which sheds light on the attractiveness of stocks relative to government bonds, remains well above the historical average. This indicates that investors are more than fairly compensated for the assumption of additional risk in equities relative to fixed income.
The road ahead finds financial markets at an interesting juncture. We find optimism in a tremendous amount of corporate and individual cash on the sidelines as well as a record number of companies posting financial results that exceed already lofty expectations. On the contrary, potential risks on the horizon solidify the need for selectivity in markets. There is potential for companies to experience margin pressure amid rising labor costs and supply chain challenges, and a host of high-profile political items may lead to wavering investor sentiment.
Expressions of opinion are as of 30 September 2021 and are subject to change without notice. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Every investor's situation is unique, and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Past performance does not guarantee future results. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that any statements, opinions or forecasts provided herein will prove to be correct.