- Pent up demand and a strong backdrop for jobs should provide momentum.
- Persistent inflation may challenge the Federal Reserve’s (Fed) policy outlook.
- High valuations reduce the margin of error.
Markets rallied through July and August, but concerns bubbled just below the surface
The private sector looks well-positioned to take the baton from policy makers. But we believe the easiest wins are behind us, and the combination of slowing, but above trend growth and inflation is tricky.
Despite a spurt of late-breaking volatility, most asset classes ended with a positive return for the quarter. Markets rallied through July and August, but concerns bubbled just below the surface. With many asset classes priced to perfection coming into September, news about the collapse of a shaky real estate developer in China prompted a spike in volatility that brought other fears to the fore. Markets ended the quarter on somewhat of a sour note as investors focused on negatives like high inflation, slowing growth and public policy dysfunction. While the S&P500® eked out a gain, tech stocks lagged on fluctuations in rates, and small caps fell on a weaker outlook. Credit held in well as investor demand continued despite heavy issuance and higher volatility. Once again, high quality assets underperformed as carry lifted returns on lower rated bonds. Commodities logged a strong performance as supply and demand imbalances persisted.
Easy wins seemed to fade during the quarter, but the outlook remains solid even as supply chain bottlenecks and a resurgence of COVID added headwinds. Over the quarter, consensus growth declined from 7% to 5%1, as data fell short of lofty expectations for rapid normalization. Consumers were discouraged by a dramatic uptick in housing prices as demand outstripped the supply of homes and rental units. Bottlenecks were everywhere as pent-up demand strained the supply chain, and pricing of everything from inputs to end products rose. Labor shortages, caused by a lack of childcare, enhanced unemployment, and the emergence of the Delta variant, added sand to the gears of the economy. While companies are signaling further price increases, earnings may come under pressure in some sectors. Despite these challenges, the economy surpassed its pre-pandemic size, even after factoring in inflation.