“Transitory” Is A Dirty Word
Arthur G. Swalley, CIMA® -Director of Investments
After a mild July and August, stock market uncertainty ratcheted up in September as volatility rose. There was no “big event” trigger, but rather a series of smaller issues that came together to result in a 5% decline in the S&P 500 from the September 2 market peak.
The quarter kicked off with markets watching China intently to determine whether the crisis engulfing the overly indebted property developer Evergrande would be a systemic risk for the global economy. For now, this risk appears contained and the losses incurred will be distributed by the Chinese government. It appears that the government is planning to contain losses to the holders of speculative stock and high yield bonds of the most leveraged property developers, while maintaining stability for the developers with strong operating protocols, as well as the underlying financial sector. This approach to allocating losses would enforce the Party’s goal of reducing moral hazard as they navigate China’s continued growth towards becoming a developed economy, with slower growth and less volatility.
As Congress reconvened from summer recess, work on the infrastructure bill was temporarily sidelined by the drama surrounding raising the debt ceiling. Markets responded negatively to the risk of Congress not carrying through on the funding of spending that Congress itself had already approved and allocated. The delay the controversy caused to the progress of the infrastructure bill also added to market uncertainty. While spirited partisan debate about spending and taxation is expected and anticipated, the prospect of shutting down government function in a partisan zero-sum game has historically led to market volatility, which is usually temporary, but completely unnecessary. As of this writing the debate on the debt ceiling has been pushed to early December.
September also saw a marked increase in supply train delays, energy prices, and inflation pressures. When we wrote this column last quarter, the Federal Reserve was still characterizing inflation pressures as “transitory”. Now, in early October, Federal Reserve Bank of Atlanta President Raphael Bostic said “Transitory is a dirty word. It is becoming increasingly clear that the feature of this episode that has animated price pressures… will not be brief. By this definition, then, the forces are not transitory. I’ve adjusted my ‘dot plot’ submissions to reflect much greater growth, much more in terms of jobs and also higher inflation.” This leads us to think interest rates will be rising sooner than current Fed forecasts as the Fed adjusts its data-based policy efforts.
All of these recent volatility pressures have the quality of being, for lack of a better word, transitory when considering the long and short-term upward trend of corporate earnings and corresponding stock price appreciation. We continue to consider tolerating stock market volatility being preferable to the mostly negative real returns available in “safe” cash and bond investments.