Q3 2021 Investment Overview

Market Summary

U.S. Market Momentum Stalls In Q3

  • The S&P 500 gained 0.6% during the third quarter, reaching an all-time high on September 2 but declining as the quarter ended. Market progress stalled as investors weighed concerns over the delta variant, inflation and the potential for moderating growth.
  • Compared with the first half of the year, style performance differentials in the third quarter were more muted. Nevertheless, large growth stocks built on their outperformance over small-cap and value stocks as the delta variant’s spread hampered the reopening trade. The large-cap Russell 1000 Growth Index gained 1.2% in the third quarter, while the small-cap Russell 2000 Value Index lost 3.0% over the same period.
  • From a sector perspective, results were mixed in the third quarter, with seven out of eleven sectors posting gains. Financial stocks within the S&P 500 led as investors gained clarity on the potential for future rate increases, gaining 2.7%. Meanwhile, industrials (-4.2%) and materials (-3.5%) lagged as businesses continued to wrestle with COVID-induced supply chain disruptions.

International Markets Continue to Lag U.S. Market

  • International markets fell further behind the U.S. in the third quarter as economic reopening remained uneven across the world. Developed international equities as measured by the MSCI EAFE Index finished the third quarter down 0.3%. Emerging market equities as measured by the MSCI EM Index ended the third quarter down 8.0% and were particularly impacted by regulatory crackdowns from the Chinese government and concerns over the risk of contagion from Chinese property market distress.

Fixed Income Muted in Q3

  • Fixed income markets gained 0.1% during the third quarter, as measured by the Bloomberg U.S. Aggregate Index. The 10-Year Treasury yield finished the quarter at 1.5%, exactly where it started, after dropping below 1.2% in early August.
  • Negative yielding debt remained slightly down from the fourth quarter of 2020’s all-time high of $18 trillion, but at around $13 trillion it sits at a historically high level. Fixed income spreads remain historically tight, while default risks have stabilized as stimulus permeates the financial system.
  • In the third quarter, the Federal Reserve’s (Fed) messaging continued to tilt towards a less accommodative stance as they signaled a tapering of asset purchases starting in the coming months. The market is now expecting the Fed to begin raising short-term interest rates in late 2022 or early 2023.

Energy Prices Lead Commodity Performance

  • Broad based commodities, as measured by the Bloomberg Commodity Index, returned 6.6% during the third quarter as supply struggled to keep up with a continued surge in demand.
  • Energy prices drove the commodity complex higher, led by a huge surge in natural gas which returned 58.6% for the third quarter. Oil prices also moved higher during the third quarter, ending at $75.8 per barrel. Agriculture and industrial metal performance moderated in the third quarter, with agriculture down 1.0% and industrial metals up 2.0%, as measured by their respective Bloomberg Sub-indices. Gold reversed course in the third quarter, losing 1% after a 3.2% gain in the second quarter.

Investment Update

Vaccination Rates Continue to Improve, And Cases and Fatalities Begin to Moderate Globally

As has been the case over the past several quarters, the broad trend of the COVID-19 pandemic continues to improve, though at a slower pace than earlier in the year. Global vaccination rates have risen steadily, which can have a wide-reaching positive effect in helping to slow the rise of additional variants, thus helping to maintain the effectiveness of existing vaccines. The improved management of the spread of the coronavirus thanks to vaccinations also offers some potential relief to supply chain issues exacerbated by the pandemic.

However, despite the U.S. having a head start of several months in many cases, other parts of the world are catching up to the domestic vaccination rate. With the approval of the COVID-19 vaccine for children ages 5-11, the U.S. vaccination rate will likely see a spike in the coming quarter as school-age children are added to the vaccinated population. But among the adult population, it seems likely that the vaccination rate may have plateaued.

Share of People Who Have Had at Least One Dose of Vaccine

Source: Our World in Data; as of 9/30/21.

As we approach the point at which vaccine uptake plateaus, combined with seemingly promising developments in treatments for COVID-19, we may soon be faced with how to proceed in an environment in which the virus is reasonably controlled but endemic. We also seem likely to see a further uncoupling of case rates from hospitalization and death rates, as an increase in vaccination rates leads to a rise in milder breakthrough cases representing a larger percentage of overall cases. This development in the coming months is likely to give us deeper insight into what changes throughout the pandemic may become a permanent part of our new normal.

Economic Growth Shows Signs of Slowing, But We Shouldn’t Be Surprised

While the economic growth we saw earlier in 2021 domestically does show signs of slowing, this should not come as a surprise given the conditions. Much of the significant growth in the first part of 2021 resulted from emerging from the steep recession we saw at the height of the pandemic, thanks to broad vaccine rollout and decreasing case rates in many parts of the country. Year over year data is now necessarily going to look less robust, as the comparisons to 2020 are no longer going to date to the lowest point of the recessionary trough in the early months of the pandemic.

Some of the sense of the slowing of growth is also a function of lofty expectations. While predictions in spring and early summer foresaw a rosier outlook thanks to vaccine availability and corresponding improvements in case rates and hospitalization, the emergence of the Delta variant slowed reopening as consumer and business behavior softened.

It’s worth noting, however, that there is an important distinction between slowing growth and contraction. Both the domestic and global Purchasing Manager Indexes (PMI) still indicate relatively strong growth.

Global Manufacturing Purchasing Manager Indexes Survey Data

Source: Bloomberg; as of 9/30/21. Levels greater than 50 are associated with expansionary periods; levels below 50 indicate a contractionary environment.

While economic growth has certainly calmed somewhat, and there are broad signs of some leveling out both globally and domestically, much of the slowing seems to be relative to earlier in the year and perhaps versus initial expectations, and underlying data still indicates that it is reasonable to expect continued growth.

Inflation Continues to Trend Higher But Is Likely Still Broadly Transitory

Inflation continues to run higher than trend, but it does seem to have possibly passed its peak and begun to moderate. As has been the case for some months, we continue to see an imbalance between supply and demand caused by a combination of supply chain problems and a high consumer savings rate. This combination of consumers with money to spend and supply hindered by staffing and manufacturing shortages and shipping delays created something of a perfect storm for rising prices. While these particular factors may be temporarily extended by the predictable increase in demand over the winter holidays, we are not convinced that they will persist long term and expect that certain of these pressures may abate over the coming months.

A tight labor market is experiencing its own conflict between supply and demand, which is likely influencing inflation in several ways. Decreasing unemployment coupled with increasing unfilled positions leads to capacity limitations that contribute to the same supply and demand imbalance previously mentioned.

Unemployment Rate and Open Positions

Source: Charles Schwab; MacroBond; as of 9/30/21. Note that The National Bureau of Economic Research announced that the COVID-19 recession ended in April 2020.

Typically, this would be a temporary problem, as open positions eventually are filled even if it takes longer than in instances of higher unemployment rates. In the current instance, however, there appears to be a direct relationship between decreasing unemployment and increasing hourly wages, which could have a longer-term impact on prices.

Unemployment Rate and Year-Over-Year Percentage Change in Average Hourly Earnings

Source: Bloomberg; as of 9/30/21. Note that The National Bureau of Economic Research announced that the COVID-19 recession ended in April 2020.

What remains to be seen is if the COVID-19 pandemic created the conditions for a genuine sea change in the relationship between the workforce and business owners. If this current trend represents a lasting wage increase for many workers, that additional cost could be reflected in longer-term, higher than average consumer price inflation.

Even if these factors result in longer-term inflation than is currently believed to be likely, we would not expect anything resembling a 1970s style stagflation given that inflation seems to be driven by wage and general economic growth, rather than prices rising independently. It is also worth noting that general inflation has been driven significantly by sectors heavily influenced by an expanded reopening as pandemic-related restrictions have been relaxed, particularly energy and hospitality.

The recent statements by the Board of Governors of the Federal Reserve also indicate that they believe inflation is, in their words, transitory and that they still have many tools at their disposal should they feel the need to rein in inflation that they feel is running hotter than is reasonable. Importantly, monetary policy is still accommodative, with interest rates near zero and the federal government continuing monthly bond purchases to help support economic growth, in part because long-range inflation has not yet hit the targets the Federal Reserve has set. According to their November statement, “with inflation having run persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer‑term inflation expectations remain well anchored at 2 percent.”1

Strong Equity Performance Still Involves Volatility at the Sector Level

Overall economic growth and the moderating of the pandemic and ensuing relaxing of COVID-19 related restrictions continue to drive strong equity market performance, and we have seen a return to more typical levels of general market volatility. The Chicago Board Options Exchange Volatility Index (VIX), which reflects expected future volatility in the S&P 500, has returned to close to average pre-pandemic levels, indicating that overall market volatility is roughly at what would be considered a normal level.

Chicago Board Options Exchange Volatility Index Historical Values

Source: Bloomberg; as of 9/30/21.

The underlying data, however, tells a slightly different story. While overall market volatility has significantly calmed since the worst of the pandemic in the spring of 2020, there has been notable volatility across various market sectors. This sector-level volatility has not contributed to overall market volatility because it has been rotational, hitting different sectors at different times. However, it is worth paying attention to despite not having market-level impacts.

Most sectors have experienced both significant drawdowns and significant growth since the start of the pandemic, particularly sectors like energy that were most immediately impacted by both pandemic-related shutdowns and ensuing reopenings.

Sector Performance Since 3/23/2020 S&P 500 Low

Source: Charles Schwab, Bloomberg; as of 10/8/2021.

While this is good news for investors with broadly diversified equity portfolios, it is a stark reminder of the value of both active and passive management strategies. While passively managed funds are well-positioned to weather broad market volatility over the long term, active management can take advantage of valuation dislocations and historically unusual factors like those we have seen related to the pandemic. It also reminds us that attempting to time the market is difficult and, often, not especially meaningful to long-term investment performance. Time in the market is more important than timing the market.


As we continue to move slowly and carefully towards what we hope is a post-pandemic world, we believe economic growth is well situated to continue at a reasonable rate, but at a slower pace than seen in the summer of 2021 in those first heady days of broad reopening. Inflation is a concern worth continuing to monitor, but we believe that the Fed still has significant tools at their disposal to moderate inflation when and if they believe it to be concerning. As we have historically done, we will continue to focus on long-term fundamentals and maintaining an appropriately diversified approach in client portfolios in order to participate in continued growth in the economy and corporate earnings while preparing for any eventual slowdown.

1Board of Governors of the Federal Reserve System. “Federal Reserve issues FOMC statement.” November 3, 2021.


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