3Q21 Insights

Investment returns in the third quarter were much more modest than those in the second quarter. However, for the nine months just ended, domestic stocks earned double-digit returns, other developed markets delivered high single-digit gains while Emerging markets returned small losses primarily due to double-digit negative returns in China.

Third quarter earnings reports begin this week, and we will be watching closely to see what companies reveal about the impact of 1) supply chain problems; 2) labor shortages and 3) continuing effects of the pandemic.

As countries emerge from restrictions due to COVID, global supply bottlenecks are leading to shortages of components needed to produce finished goods. In turn, raw materials costs are rising and pressuring manufacturers’ bottom lines.

What does this mean for inflation? Will companies take a different tact about absorbing cost increases in this climate? James Bullard, President of the St. Louis Federal Reserve is concerned: “I am concerned about the changing mentality I would say around prices in the economy and the relative freedom that businesses feel that they can pass on increased costs easily to their customers.” “For years this has not been the case in the U.S. They felt like if they raised prices they would lose market share. It would hurt their business and customers were rabid about moving to the lower-cost and low-cost products. That may be breaking down.” His outlook for core inflation (excluding food and energy) in 2022 is 2.8% – well above the Fed’s proclaimed 2% target. As we closed out the quarter, energy and financial stocks were strong performers. Crude oil and natural gas are trading at their highest levels in several years and show no signs of slowing down. The inflationary impact of rising energy prices is helping push bond yields higher which in turn makes financial stocks look more attractive.

In our last quarterly report, we asked the question: Is there too much complacency regarding stock prices? Morgan Stanley strategists commented recently that they don’t believe supply chain problems have been fully factored into the market’s expectations for corporate earnings. This leads us to the final point in that report – there could be room for some unpleasant surprises in the upcoming earnings reports.

China remains in the financial/economic news (when has it not been?) about the implications of China’s crackdown on its tech sector and possible implications for our tech sector? A new plan in China aims to restrain the algorithms that power tech platforms and to curb the influence of giant internet companies. Analysts suggest that tightening controls over algorithms without crimping growth or innovation in one of China’s most successful sectors will be a challenge for regulators. China is not alone in implementing these types of controls, but they are ahead of the U.S. and the European Union thus far. It seems clear that their efforts will have an impact on U.S. based companies doing business in China. Over the coming three years we should have a much better idea as to the extent of these controls.

Also in the news recently has been the debt incurred by real estate developers in China. Sales of projects developed over the last 10 years in some of the largest cities are beginning to wane and buyers are balking at prices. Developers are strapped for cash as they struggle to make debt payments to the point that Beijing is imposing borrowing curbs. Demographics of prospective buyers are looking dimmer and the government is trying to address the situation without damaging the economy. Certainly something for us to keep an eye on as ripples in one asset class in a country with the economic significance of China can have far-reaching consequences.

As we head toward year-end there is no shortage of market-moving issues to monitor. That likely will entail price volatility as events unfold and we are happy to field your questions and address your concerns.

The KKRA Team