Quarterly Update

Tom Galvin, Chief Investment Officer | Oct. 2021

Transition to a Self-Sustaining Recovery

Vaccination progress kicks off multi-year expansion

Inflation to remain elevated until second half of 2022

Expect more modest equity gains ahead and higher volatility

As we head into the final quarter of the year, the robust optimism that characterized the economic recovery and market sentiment in the spring has given way to a more measured outlook. The impacts of the Delta variant, fading fiscal stimulus and continuing global supply shortages have all led to a notable slowdown in economic momentum and a dip in both consumer and businesses confidence. We continue to see a durable multi-year expansion unfolding and view the recent soft patch as largely temporary, with most of the activity suppressed by shortages and virus fears merely delayed rather than lost forever. Economic demand remains strong and people are anxious to return to more normal lives. However, the setback in the recovery is also a reminder of how tethered, for now, the economy remains to the pandemic, and that near-term challenges could be a source of volatility in markets in coming months.

The most encouraging recent development for us has occurred on the virus front. Infections have dropped nearly 60% since early September, while vaccines continue to prove highly effective in reducing rates of serious illness that have stressed the nation’s hospital system. Bold pronouncements about the demise of COVID-19 have invariably proved to be false dawns, as the virus has time and again refused to comply with our hopes or expectations. Yet, with vaccinations nearing 70% of the population, booster shots becoming widely available, and a green light from the FDA for vaccination use on children, we nevertheless see real reasons for optimism that the worst of the pandemic is finally behind us and that future resurgences in infections will prove less and less disruptive to economic activity.

Fading pandemic impacts will also go a long way towards addressing the supply challenges that have weighed on both consumption and production. Although substantial stimulus has underwritten a rapid rebound in global economic activity, the robust recovery has also brought growing pains with it. International supply chains are stressed, labor shortages have emerged, and inflation is heating up, with the reopening of the economy creating a flood of demand for the same items and services coming all at once. It will take some time, but we think these issues are all solvable. Businesses are increasing capacity as more restrictions on activity are lifted, and as more production comes online, bottlenecks and price pressures will ease. At the same time, labor participation is expected to increase as pandemic stimulus savings run down, vaccination rates build and virus fears fade.

While we acknowledge that near-term price pressures have extended beyond our initial estimates, and will likely remain elevated through the first half of 2022 before supply-demand imbalances are brought back into equilibrium, we continue to believe inflation is not a long-term problem. Many of the past decade’s disinflationary forces – globalization, demographics, technology adoption, etc. – are structural in nature, and a sharp recovery from the COVID-19 crisis will not change this. In the meanwhile, we think that consumers can withstand a temporary rise in costs and that the impact on the economy will be manageable. Household finances are in strong shape, with over $2 trillion in excess savings, and wages are rising at the fastest rate in more than a decade.

Over the next year, the current policy-induced recovery should give way to more organic and self-sustained growth. In Washington, another significant round of higher spending is in the pipeline, but unlike the direct stimulus of earlier pandemic relief bills, this package will be stretched out over 10 years and paid for with higher taxes. Likewise, the Fed has started down the long road towards policy normalization. Policy should remain highly accommodative for some time and rate hikes are still off in the distance, but officials appear set to begin removing some stimulus by reducing asset purchases later this year. From an investment perspective, this still broadly positive fundamental outlook remains constructive for risk assets and we continue to view stocks and high-yield credit as attractive over low-yielding investment grade bonds and Treasuries.

However, investors have enjoyed a tremendous ride since the pandemic lows of March 2020, with the value of the S&P 500 doubling in record time, and, as the economic cycle transitions to expansion, we expect the pace of gains to slow and market sentiment to be more vulnerable to potential headwinds. Indeed, concerns over Fed tapering and rising bond yields, the U.S. debt ceiling, potential higher taxes, inflation pressures, slowing economic and earnings growth projections, and Chinese property markets have all played a role in driving recent volatility and the market’s first 5% pullback in nearly a year. The list is long, but we don’t think these concerns pose a significant threat to the long-term outlook, and that the steadiness and strength of the rally over the first half of the year has probably prompted more headlines and worries than are necessarily warranted.

Still, for now investors have more questions than answers, and a more balanced landscape of risks does raise the prospect of further volatility in coming months, as well as a potential market correction. Corrections, though, are often healthy events, helping to eliminate excesses that have built up after extended periods of market optimism and setting a firmer foundation for future gains. Even the best markets need a breather now and then. We think this bull market still has a lot of room to run, and that the combination of sustained economic growth, robust earnings and ongoing policy support will remain a tailwind for stock prices. We’re still a lot closer to the beginning of this expansion than we are to the end, and investors may want to use any weakness ahead as an opportunity to add to core positions.

Key Points

Vaccination progress kicks off multi-year expansion

Inflation to remain elevated until second half of 2022

Expect more modest equity gains ahead and higher volatility

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Alternative investments are speculative, entail substantial risks, offer limited or no liquidity and are not suitable for all investors. These investments have limited transparency to the funds’ investments and may involve leverage which magnifies both losses and gains, including the risk of loss of the entire investment. Alternative investments have varying, and lengthy lockup provisions.

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