“Doubt is not a pleasant condition, but certainty is absurd.” – Voltaire (1694-1778)
After a strong second quarter for stocks and other risk assets, market volatility in the third quarter reminded us that markets could indeed go down, if only for a short while. Bond markets sold off a bit at the end of the quarter as rates rose following the Federal Open Market Committee’s statement on September 22 that indicated asset purchase tapering could begin soon. Chinese stocks sold off as the Chinese Communist Party continued its crackdown on private enterprise and concerns over a debt crisis at Evergrande, the large Chinese real estate development company, sparked some apprehension in capital markets around the world.
Equity markets were mixed in the third quarter. U.S. large cap stocks as measured by the S&P 500 ended the quarter in the black posting a gain of 0.58%, bringing the year-to-date return to 15.92%. Most other major markets struggled in the third quarter: U.S. small-cap stocks (Russell 2000) returned -4.36%, international stocks (MSCI-EAFE) returned -0.45%, and emerging markets (MSCI-EM) returned -8.09%. Bond market returns were muted in the third quarter. The Barclays Bloomberg U.S. Aggregate Index eked out a 0.05% return in the third quarter and is down -1.55% for the year-to-date. Municipal bond prices have been somewhat buoyed by concerns over rising tax rates. Despite the fears of rising tax rates, the Barclays Bloomberg Municipal 6-8 Year Index fell -0.03% in the third quarter and has returned a paltry, but positive, 0.15% for the year.
Economic indicators continued to send somewhat mixed messages in the third quarter. The August 12-month CPI was 5.3%. Inflation was especially acute in energy, which consists primarily of gasoline and electricity, where inflation ran at 25% over the previous year. Gasoline prices increased 42.7% over the previous twelve months. In addition to rising energy prices, a tight labor market and continuing supply chain bottlenecks contributed to rising prices. U.S. GDP grew 6.6% in the second quarter, providing additional support for the idea that the post-COVID recovery is still in full swing. In response to this evidence of the U.S. economy beginning to function at near full capacity, the Federal Reserve’s Open Market Committee indicated that they may soon begin tapering asset purchases, stating, “If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted.” This seemed to indicate that the Fed had moved beyond “talking about talking about” tapering the asset purchasing program to full on “talking about” tapering and it could be the first step toward a long-expected rise in interest rate policy. In response the 10-Year U.S. Treasury yield rose from 1.32% on September 22 to 1.52% on September 30. While we began to see a tiny glimpse of future monetary policy, fiscal policy continues to be uncertain, with President Biden’s signature $3.5 trillion stimulus bill and the bipartisan $1 trillion infrastructure bill languishing in Congress.
The art of portfolio management is, at least in part, dependent upon one’s ability to navigate an uncertain future, and position one’s portfolio accordingly. Admitting to living in a probabilistic world and using that as a basis for developing a well-balanced and diversified portfolio can be inherently uncomfortable, because at its core it is an admission that we do not know what the future holds. It is far more comforting in the moment to feign certainty and move forward with perceived clarity of vision that one has future events mapped out and has accounted for the consequences of those events to create a fully formed investment plan. Better to suffer the uncomfortable that accompany admitting to uncertainty and planning accordingly, than suffering the consequences of the illusion and absurdity of certainty.
As always, please let us know if you would like to discuss your portfolio or current market conditions in greater depth.