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Finally Fall — Week of September 27, 2021

Written by Steve Orr, Chief Investment Officer, and Greg Kalb, Investment Advisor

index wtd ytd 1-year 3-year 5-year index level
S&P 500 Index 0.52 19.86 39.69 17.21 17.70 4,452.39
Dow Jones Industrial Average 0.62 15.28 32.51 11.87 16.36 35,038.67
Russell 2000 Small Cap 0.51 14.59 56.43 11.04 13.81 2,275.70
NASDAQ Composite 0.03 17.34 42.56 24.66 24.44 14,972.74
MSCI Europe, Australasia & Far East -0.26 11.51 29.78 8.89 9.80 2,341.69
MSCI Emerging Markets -1.01 -0.25 20.14 9.47 9.45 1,265.10
Barclays U.S. Aggregate Bond Index -0.40 -1.16 -0.62 5.56 3.03 2,364.23
Merrill Lynch Intermediate Municipal -0.18 0.98 2.40 4.95 3.07 320.23

As of market close September 24, 2021. Returns in percent.

Finally Fall

The temperatures finally broke last week and so did interest rates. Realizing that the Fed is now serious about tapering, bond traders pushed yields higher. The 10-year Treasury spent most of August and September in a tight range around 1.3%. The Fed’s announcement that it is close to a decision promptly added 0.15% to the 10-year, pushing its yield to 1.45%. That change may seem small for a car or home loan, but speaking as a former bond trader, it’s a good-sized move.

Stocks reacted well to the Fed’s news, halting a twelve-day march below key moving averages. Despite climbing higher for the week, all the major indices remain in short-term downtrends. The S&P 500 has traded lower in only 15 of the last 40 trading days, but the down day drops have been further than the up moves. Last Monday’s 1.7% drop saw decliners outstrip gainers by a four-to-one margin. The balance of the week saw most indices recover that drop in steady action. We would like to see another 2.5% to 3% rally and a short-term trend change. 

This month S&P 500 sector performance ranges from flat to down 5%. Utilities, which generally do not like rising interest rates, are the laggard. Not surprisingly, energy remains the bright spot, up 5% for the month, and over 34% for 2021. Discipline in supply control from OPEC combined with lower production of natural gas has pushed prices higher. Growth stocks have fared better by a half of a percent over Value; Small has outpaced Large. Overseas emerging markets continue to struggle with the impact of Evergrande on Chinese markets. Europe was improving until last week’s energy problems hit the news. 

Big Brick

In last week’s note, we looked at some of the bricks in the market’s Wall of Worry. Markets climb walls of worry because humans tend to look at the news of the moment while markets look ahead to possibilities. The slow implosion of the Chinese property developer Evergrande continued as the firm missed an interest payment last Thursday. At this writing there is no official word from the Communist Party regarding the firm’s fate. Over the weekend at least two local governments seized pre-sale revenues from Evergrande projects. These actions appear to be attempts to protect apartment buyers from losing down payments in unfinished projects.  

The debt ceiling brick is an investor sentiment issue. The debt ceiling has been raised 80 times in the last century and each vote has narrowly avoided a “crisis.” Please bear in mind that the debt limit is the “part 2” of an out-of-order 2-part process. First Congress decides how much to spend, then dithers around and waits until funding is about to run out before raising the debt limit. Most countries do not bother with a debt limit of any kind — it is an artificial constraint. It generally is unnecessary political theater. 

The biggest brick, or obstacle to economic growth, is the Europe/U.K. natural gas shortage. The energy shortage has three origins, two political and the other supply. Shutdowns from the virus have curtailed gas production in many fields around the world. Europe buys much of its gas from Russia via several pipelines. Recently Putin has decided to limit gas flow through the Ukraine to 70% of the usual level. Thus, European distributors are not able to restock reservoirs for the winter. Gas has also become very expensive thanks to decisions to tax fossil fuels. The taxes are supposed to fund renewable projects such as North Sea windmills. As a result, natural gas futures have doubled in price over the last year. 

Gas Me Up

“But wait, there’s more” as they say on TV. Lack of natural gas is making food disappear from U.K. grocery stores. How’s that? Natural gas has become so expensive that the two largest fertilizer plants in northern England have shut down. Those plants produce almost pure carbon dioxide — 60% of the country’s supply. Isn’t CO2 a “bad” greenhouse gas? Well apparently, yes, but these plants bottle the gas and sell it for industrial uses. A short list: medical procedures, flash freezing perishables, preparing animals for rendering and packing. Medical uses come first, so British meat packers are shutting down. The Telegraph and Financial Times websites show empty shelves in stores. 

Even if CO2 were available, there is a serious shortage of truck drivers due to virus travel restrictions. The carbon taxes have added to higher electricity prices across Europe. About 25% of Britain’s electricity comes from North Sea wind turbines. Their output has fallen to a quarter of normal levels thanks to an unusual weather effect. Prices for wholesale power in the U.K. have quadrupled, and several small power resellers are headed for bankruptcy. The situation appears to be a summer version of last February in Texas. Britain has backup undersea electrical cables from France, but they caught fire last week and are temporarily off-line. Winter is coming… 

Fed Follow Through

Recall that the Fed has been buying $80 billion of Treasury bonds and $40 billion of mortgages each month since last April. The goal was to stabilize the bond markets and place excess reserves in the banking system. The plan worked well. Calls have come for several months from both inside and outside the Fed to end the program, as it has served its purpose. 

The Committee’s post-meeting statement and Chairman Powell’s press conference comments make it very likely that the Fed will vote at its November meeting to begin lowering the amount of bonds it purchases (“tapering”). The reductions in purchases would start either in December or January. Of course, if economic conditions deteriorate, the Fed could ramp purchases back up. The statement about tapering “if progress continues broadly as expected” gives the Committee a low bar. We still think a September jobs report around 500,000 and a drop towards 5% unemployment would be enough. 

Powell stated that tapering would likely end by the middle of 2022, a faster path than prior tapers. He reiterated that there would be no rate hikes until after the taper is finished. If the Fed follows through with a mid-2022 plan, that will only leave a few months before November elections. It would be a rare event for the Fed to move rates that close to national elections. 

Scorecard

Food and power issues could slice fourth quarter GDP for Europe by at least a third. Delta certainly tamped down growth this quarter here and abroad. We note that the delta wave peaked a month ago nationally as of today. Hotspots remain, however. Decatur, just north of the DFW metroplex, has tents outside of its hospital to cope with patient overflow. We are cognizant, too, of the unrelenting nature of viruses. They are constantly evolving to survive. The R.1 variant, first identified in a Kentucky nursing home, is spreading rapidly. 

Wrap-Up

The Fed had no big surprises for the markets last week, a testimony to effective communication from the current leadership. We note that the Fed’s Summary of Economic Projections had slightly lower growth in the fourth quarter, but the Fed increased its estimate for first-quarter growth. This makes sense to us, as supply chains slowly heal, and variants hopefully become less of an issue. 
Certainly, there are news events on offer that can move markets. Stocks appear to be settling into a consolidation range and rebuilding energy. September has been calm so far compared to most Septembers. Let’s keep it that way.  


Steve Orr is the Executive Vice President and Chief Investment Officer for Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary's University School of Law. Follow him on Twitter here. Greg Kalb is an Investment Advisor at Texas Capital Bank Private Wealth Advisors. He holds a Bachelor of Arts from The University of Texas at Austin.

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