With the end of 2021 coming into focus, market commentators
are beginning to share their expectations for what the fourth quarter may
ultimately deliver in the global equity and fixed-income markets.
According to Nigel Green, CEO of the deVere Group, investors
should brace themselves for a possible 10% market correction over the next
month, driven by uncertainty about the U.S. Federal Reserve’s thinking on
interest rates. This forecast comes as the Federal Reserve announced Wednesday
that it will start unwinding its $120 billion monthly bond purchases later this
month.
“While Fed Chair Jay Powell will be talking about the
tapering of the massive bond-buying program, the real story for the markets is
how the Fed, the world’s de facto central bank, will talk about inflation,”
Green says. “Inflation is running hotter and is becoming a bigger issue than
most analysts previously expected. As such, investors will be trying to get a
handle on how the Fed intends to fight the trend of higher prices by starting
to raise interest rates.”
Central bankers are slowly acknowledging that inflation may
be stickier than expected. At the same time, the baseline view remains that
inflation will settle back to historical norms over time, says Ryan Detrick,
LPL Financial chief market strategist. While inflation has come down some
recently, he expects there may be another swing higher in the fourth quarter or
early next year as the post-COVID-19 reopening pushes prices higher in areas
where the Delta variant had dampened economic activity. Examples in this
category include airfares, lodging and used cars.
The consensus expectation of Bloomberg-surveyed economists
is that Consumer Price Index (CPI) year-trailing inflation will fall to 3.3% by
the end of 2022 and 2.3% at the end of 2023. Many consumers, though, are
finding inflation risks scarier, because they’re sensitive to prices in grocery
stores and at the gas pump—and because of heavy news coverage, Detrick says. In
his view, the wild card remains how long it will take supply chain disruptions
to sort themselves out, as they have been a key source of imbalances between
supply and demand that have pushed prices higher.
“This means that [the Fed is] likely to have to raise interest
rates sooner and/or more aggressively,” Green says. “Therefore, markets are
actively pricing in two or three hikes next year, and this could lead to a 5%
to 10% market adjustment over the next month.”
On the positive side, third-quarter earnings results have
been good overall, Detrick says, adding that companies have generally done well
managing through supply chain disruptions, labor and materials shortages—and
the related cost pressures. A solid 82% of the roughly 280 S&P 500
companies that have reported earnings have exceeded their targets.
But there are reasons for concern, Detrick continues. Profit
margins are well above their pre-pandemic highs and, in this sense, they carry
increased downside risk in the near future. Additionally, labor is in short
supply, with 10.4 million job openings, according to the Bureau of Labor
Statistics (BLS), which is about 3 million more than pre-pandemic levels. This
means employers are having to pay up for talent, and wage growth accelerated to
4.6% year-over-year in September. Unless the prevailing economic environment
changes, wages will likely rise further—adding to the shortages of materials
that have pushed prices up for manufacturers.
These pressures on companies’ costs could impair profit
margins if they continue to build. Consumers and businesses can afford to pay
higher prices now but may balk at some point, Detrick says. For now, strong
revenue growth is overshadowing these margin pressures, he says, but with stock
valuations elevated, it is important that earnings come through, or the markets
may get spooked.
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