Who doesn’t want to dig into 30 pages of charts amidst quotes from everyone’s favorite futbol coach?!
- Market Volatility: “Taking on a challenge is a lot like riding a horse, isn’t it? If you’re comfortable while you’re doing it, you’re probably doing it wrong.”
- Inflation Concerns: “He’s Here, He’s There, He’s Every ‘Fricken Where – Roy Kent Inflation”
- Protect Against Drawdowns: “There’s two buttons I never like to hit: that’s panic and snooze.”
Quick takeaways below, but we’d encourage you to read the whole piece. Contributions from the team, written by Dave, inspired by Ted.
The Backdrop for Q4 2021:
- Health of the Consumer – We believe the aggregate consumer is flush with cash, and once pent-up demand can safely be unleashed, the U.S. economy is set to rip higher. While we know that the cruel nature of the pandemic has had an adverse financial impact on many (particularly those less fortunate), in aggregate, the consumer coffers are presently funded. Relative to before COVID (Q1 2020), the average U.S. Household are worth ~30% more. Consumer balance sheets are well fortified and flush with cash – ready to spend when supply chain and virus risks ease.
- Better than Anticipated Earnings – After reaching nearly $165 on a trailing twelve-month basis for S&P 500 EPS at the end of 2019, the pandemic resulted in only a 15% drawdown in earnings – it only take 6 quarters to recoup the damages. We remain optimistic, as we continue to see the full-year 2021 estimates from Wall Street analysts continues to grind higher, now standing at $200 – well above the 2019 level. Given the health of the consumer, and if we see peak supply chain stress in the market, we believe that there is upside to these estimates.
- Fed Tapering Misstep – For the most of Q2 and Q3, the yield curve paused its steepening. Now, it is up the Fed Chair Jerome Powell to recognize the level of flattening. This means caution in communication if the Fed is to avoid the mistakes of the Yellen Fed, namely inverting the yield curve and slowing the flow of liquidity to main street by redirecting said liquidity towards Wall Street. We believe that tapering could offset this flattening, though even after the announcement in Jackson Hole, it has yet to be seen.
- Longer-than-Expected Supply Chain Issues – It’s no secret that there is a supply chain problem in the United States. Furthermore, it appears to be lasting much longer than originally anticipated. Given the lack of supply, coupled with extreme demand, we’ve seen substantial increases to the price of goods. If these bottlenecks continue to persist, it could dampen future expectations for consumer spending.
- Possible Policy Errors Through Fiscal Tightening (Taxes) in 2022 – The lags associated with the long-term benefits of infrastructure spending are notoriously long and variable. Tax increases, on the other hand, tend to be retroactive and immediate. From a market perspective, the fear is that a fiscal drag sterilizes the positive impacts of reopening and already passed stimulus, leading to an economic environment more consistent with the period of secular stagnation after the GFC.
- Faster-than-Expected Inflation – The magnitude of the policy actions used to counteract deflation may, in the end, be hugely inflationary. Higher-than-expected inflation tends to be a major headwind to equity valuations. Right now, 5YR inflation breakeven figures are well above the Fed’s 2% target. For markets, how the Fed chooses to address inflation is as important as the inflation itself.
See the full report here, fun and informative!
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