Equity markets were lower in September, as major indices were down low to mid-single-digit percentages. Bond prices also fell as interest rates rose some in the month. While autumn has a reputation for being a difficult time for markets, there are a variety of potential causes for the pullback other than the calendar.
In our view, the most significant cause is a relative change in tone from central bankers on inflation. Generally, the comments have turned more hawkish as inflation has picked up. There are expectations for tapering to begin soon, and some are discussing possible rate hikes towards the end of 2022. We think central bankers want to normalize policy, but whether they have the guts to meaningfully reduce liquidity is another matter. In the meantime, the market seems to be reacting to incremental, directional changes in forecasted liquidity.
Commentators are debating whether recent inflation is transitory. What one thinks tends to be dependent on how “inflation” and “transitory” are defined. The longer there are supply chain shortages, the less transitory it feels. The harder it is to find workers, the more bargaining power they have. However, many of these shortages are knock-on effects from the pandemic which has lasted longer than many have forecasted. The key question, in our view, is when can the supply of labor and goods begin to normalize? That answer still appears to be “TBD.”
Another source of uncertainty is the political theater taking place in Washington. Policy uncertainty impacts everyone’s ability to make long- term decisions about the future. Between debt ceiling brinksmanship, which nobody seems to take seriously, and the next round of government intervention, Congress appears dysfunctional. It seems reasonable to think that the government will pass some legislation. What that ultimately looks like and when it happens also appear to be “TBD.”
Our view is that the US economy is doing just fine, the recovery is coming along, and if those two things continue to be true then earnings for companies should hold up. Whether the market cheers them is a different matter, but we also think that volatility is a feature of markets, and it helps keep animal spirits in check. So, while we do not enjoy living through it, we can appreciate short-term bouts of it while we focus on the long-term.