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An Independent Financial Advisory Firm
Magnus Financial Group LLC is an independent, SEC-registered investment management firm headquartered in New York City. We specialize in providing customized wealth management and financial planning services to a diverse clientele, including high-net-worth individuals.
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Market Commentary
Market Commentary – August, 2021
Under the Surface
In August, the S&P 500 Index rallied for a seventh consecutive month and registered a new record high of 4,523, its 53rd record high of the year.
Markets
The S&P 500 Index rallied yet again in August, its seventh consecutive monthly gain. On the last day of the month, the index registered a new record high of 4,523, its 53rd record\ high of the year. Indeed, with an eight-month gain of 21.6%, the S&P is on the way to one of its best years in the last half century. This impressive streak has been coupled with minimal volatility: the largest drawdown so far this year was just -4%1 (The 50-year average is -14%.)1 Foreign large cap stocks have also performed well, rising 12% for the year. U.S. high yield corporate bonds, which are 4.5% higher for the year, also benefited from the increased appetite for risk. High yield spreads closed the month at just 288 basis points, near a record low. Indeed, across every major credit category, spreads are either at or near their all-time lows. On the other hand, safe haven investments have suffered. U.S. intermediate-term bonds, intermediate-term municipal bonds, and gold all declined in August, albeit less than 1%.
Looking at the stock market’s gains since the pandemic lows, the current bull market sits comfortably at the top of the list of most remarkable in the post-War era.2 But with the sizable gains comes rising risks. An almost eerie calm – along with substantially higher valuations of all assets – hides pressures building under the surface.
These gains were not without reason. The economy and labor market have improved, corporate earnings have grown, and the vaccine rollout has been robust.3 But more notable than all of these factors is the massive amount of fiscal spending, largely funded by the Federal Reserve’s continued bond buying. As such, investors are on the lookout for signs the support may be reduced. For instance, after months of exceptional labor market gains, a good, but weaker-than-expected, round of August payrolls (released on September 3) softened expectations for any tapering of Fed bond buying.4
At the Federal Reserve’s Jackson Hole Economic Symposium, Fed Chairman Jerome Powell suggested the Fed may taper bond purchases later this year, while simultaneously emphasizing that the labor market was far from healed, implying substantial further support would be needed.
Jackson Hole
On August 27, 2021, Fed Chairman Jerome Powell shared his keynote comments at the Federal Reserve’s virtual Jackson Hole Economic Symposium.5 In a speech reminiscent of the Greenspan era, Powell spoke a lot without saying much at all. His comments included enough hawkish language to suggest the Fed was paying attention to growing inflation pressures, but he also indicated that the recent jump in inflation was transitory.
Powell also suggested the Fed may taper bond purchases later this year, while simultaneously emphasizing that the labor market was far from healed, implying substantial further support would be needed.
The Federal Reserve may be confident that inflation is transitory, but consumers are more skeptical. A Conference Board survey of consumer confidence for August showed that consumer inflation expectations over the next 12 months had increased to 6.8%, a 10-year high.
Finally, Powell appeared to solidify the Fed’s relatively dovish bias as he laid out the risks of removing monetary support too soon.
“Indeed, responding [reducing support] may do more harm than good, particularly in an era where policy rates are much closer to the effective lower bound even in good times. The main influence of monetary policy on inflation can come after a lag of a year or more. If a central bank tightens policy in response to factors that turn out to be temporary, the main policy effects are likely to arrive after the need has passed. The ill-timed policy move unnecessarily slows hiring and other economic activity and pushes inflation lower than desired. Today, with substantial slack remaining in the labor market and the pandemic continuing, such a mistake could be particularly harmful. We know that extended periods of unemployment can mean lasting harm to workers and to the productive capacity of the economy.”5
The U.S. dollar declined by almost half a percent on Powell’s comments, confirming his dovish stance and suggesting the market had expected more clarity on when support would be withdrawn. Regardless of what was said, the Fed continued, at pace, with their bond buying program. For the four weeks ending August 25, the Fed purchased an additional $111 billion worth of bonds, bringing their balance sheet to well over $8.3 trillion.6 And while the Fed may be confident that inflation is transitory, consumers are more skeptical. A Conference Board survey of consumer confidence for August showed that consumer inflation expectations over the next 12 months had increased to 6.8%, a 10-year high.7
Historically, the Chinese Communist Party has used regulation to push companies to serve the CCP’s economic, social, and national-security concerns. Most recently, the CCP has announced measures such as banning for-profit enterprises in the education sector, restricting gaming activity for kids and suppressing alcohol consumption.
Chinese Regulatory Crackdown
While U.S. and developed countries’ equity markets have been remarkably stable in 2021, Chinese markets sold off 32% from February 17th to August 20th amid the latest round of regulatory reform by the Chinese Communist Party (CCP). The crackdown began with the cancellation of Chinese financial giant Ant Group’s IPO, scheduled to take place in November 2020.8 Valued at over $300 billion, the company was expected to overtake oil giant Saudi Aramco as the world’s largest initial public listing.9 However, after Ant Group founder and Alibaba CEO Jack Ma apparently disparaged Chinese banking regulations,8 the CCP introduced more stringent lending laws, which hurt Ant’s lending and credit business and therefore threatened nearly 40% of the company’s revenue.9 Ant subsequently decided to postpone its listing amid what would have been a much lower valuation for a substantially altered business. In addition, the CCP launched an anti-trust investigation into e-commerce giant Alibaba, resulting in a record $2.8 billion fine, a direct retaliation by the CCP against Ma.10In an even stranger turn of events, the normally charismatic Jack Ma disappeared from the public eye without much explanation. Some even speculated the Chinese government had taken him hostage, until he reappeared three months later.11
This isn’t the first time the Chinese government has increased corporate regulations. Historically, it has done so to push companies to serve the CCP’s economic, social, and national-security concerns.10 Since Ant’s failed IPO, the CCP has announced and implemented several new regulatory measures, including:
Setting aside these policies’ attempts at social engineering, they represented new and unexpected rules, costs, and uncertainty for markets, wiping out over $1 trillion in market value in just a few months, and there is fear that more regulation is coming.16 Chinese tech companies have been popular investments in international portfolios over the last decade, despite a Chinese law that forbids them to list on foreign exchanges.17 To circumnavigate the law, these firms set up structures called Variable Interest Entities (VIEs), offshore shell companies that enable mainland Chinese firms to list in overseas markets and attract international capital. Some analysts speculate that the CCP will crackdown on this activity, cutting off international investment and triggering massive capital outflows, which would permanently impair the value of these firms.18As a result, Chinese companies that are organized as VIEs have been hit the hardest. Among these firms are Tencent and Alibaba, down 38% and 47% from their respective highs.
Looking Forward
Record-high equity prices reflect fundamental improvement in the economy and earnings backdrop. That said, part of this improvement has unquestionably been driven by massive amounts of stimulus pumped into the economy and markets. Investors are right, therefore, to focus on the Fed and when it might withdraw support. Recent comments from Fed Chairman Powell suggest the Fed currently favors more, rather than less, support. But there is an additional element of the policy backdrop that also needs to be watched. The U.S. Treasury ended August with an operating cash balance of just $356 billion, down from almost $1.8 trillion at the start of the year.19 At the beginning of August, the Treasury expected to need to issue almost $1.4 trillion of debt in the back half of the year.20 This assumption was based on known expenditures and a presumed increase in the debt limit, which is yet to occur.20 As it stands, Treasury estimates it will run out of operating cash around the middle of October 2021.21 Assuming that Congress is able to find a way to raise the debt ceiling, this could lead to a dramatic increase in debt issuance, which has the potential to put upwards pressure on bond yields.
Performance Disclosures
All market pricing and performance data from Bloomberg, unless otherwise cited. Asset class and sector performance are gross of fees unless otherwise indicated.
Citations
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Disclaimer
Magnus Financial Group LLC (“Magnus”) did not produce and bears no responsibility for any part of this report whatsoever, including but not limited to any microeconomic views, inaccuracies or any errors or omissions. Research and data used in the presentation have come from third-party sources that Magnus has not independently verified presentation and the opinions expressed are not by Magnus or its employees and are current only as of the time made and are subject to change without notice.
This report may include estimates, projections or other forward-looking statements, however, due to numerous factors, actual events may differ substantially from those presented. The graphs and tables making up this report have been based on unaudited, third-party data and performance information provided to us by one or more commercial databases. Except for the historical information contained in this report, certain matters are forward looking statements or projections that are dependent upon risks and uncertainties, including but not limited to factors and considerations such as general market volatility, global economic risk, geopolitical risk, currency risk and other country-specific factors, fiscal and monetary policy, the level of interest rates, security-specific risks, and historical market segment or sector performance relationships as they relate to the business and economic cycle.
Additionally, please be aware that past performance is not a guide to the future performance of any manager or strategy, and that the performance results and historical information provided displayed herein may have been adversely or favorably impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be inferred that these results are indicative of the future performance of any strategy, index, fund, manager or group of managers. Index benchmarks contained in this report are provided so that performance can be compared with the performance of well-known and widely recognized indices. Index results assume the re-investment of all dividends and interest and do not reflect any management fees, transaction costs or expenses.
The information provided is not intended to be, and should not be construed as, investment, legal or tax advice nor should such information contained herein be construed as a recommendation or advice to purchase or sell any security, investment, or portfolio allocation. An investor should consult with their financial advisor to determine the appropriate investment strategies and investment vehicles. Investment decisions should be made based on the investor’s specific financial needs and objectives, goals, time horizon and risk tolerance. This presentation makes no implied or express recommendations concerning the way any client’s accounts should or would be handled, as appropriate investment decisions depend upon the client’s specific investment objectives.
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Definitions
Asset class performance was measured using the following benchmarks: U.S. Large Cap Stocks: S&P 500 TR Index; U.S. Small & Micro Cap: Russell 2000 TR Index; Intl Dev Large Cap Stocks: MSCI EAFE GR Index; Emerging & Frontier Market Stocks: MSCI Emerging Markets GR Index; U.S. Intermediate-Term Muni Bonds: Bloomberg Barclays 1-10 (1-12 Yr) Muni Bond TR Index; U.S. Intermediate-Term Bonds: Bloomberg Barclays U.S. Aggregate Bond TR Index; U.S. High Yield Bonds: Bloomberg Barclays U.S. Corporate High Yield TR Index; U.S. Bank Loans: S&P/LSTA U.S. Leveraged Loan Index; Intl Developed Bonds: Bloomberg Barclays Global Aggregate ex-U.S. Index; Emerging & Frontier Market Bonds: JPMorgan EMBI Global Diversified TR Index; U.S. REITs: MSCI U.S. REIT GR Index, Ex U.S. Real Estate Securities: S&P Global Ex-U.S. Property TR Index; Commodity Futures: Bloomberg Commodity TR Index; Midstream Energy: Alerian MLP TR Index; Gold: LBMA Gold Price, U.S. 60/40: 60% S&P 500 TR Index; 40% Bloomberg Barclays U.S. Aggregate Bond TR Index; Global 60/40: 60% MSCI ACWI GR Index; 40% Bloomberg Barclays Global Aggregate Bond TR Index.