Marketplace valuations have reached new heights, and interest rates have revisited lows. So naturally, it is normal to experience more uneasiness and weariness around the limits of financial returns, creating heightened awareness in all those involved. Indeed, anything vaguely connected with the delta-variant, inflation, credit defaults, government deadlocks, and challenging labor markets can captivate the public right now.
First, fantastic news recently came out about an effective oral drug for treating COVID-19, which has economic significance. Specifically, Merck, a pharmaceutical company, announced significant trial results for an oral medicine that contained meaningful trial results on a large sample of unvaccinated people who had the infection. The drug showed reduced illness severity and better recovery times. Such news is welcomed from an investment perspective because it can improve the confidence in people’s daily economic lives, resulting in less uncertainty for returns in the equity, bond, and real estate markets.
But in labor markets, things are more challenging. For one, the labor market is tight, resulting in increased bargaining power for labor. Tightness is notably visible in the number of available jobs per unemployed person. Currently, that ratio is much greater than one. In addition, labor reports indicate that a massive skill gap is out there. Many major employers are simply finding it hard to find qualified labor. As a result, labor shortages are an essential factor impeding the monthly manufacturing surveys. Unfortunately, these acute problems could result in lost future revenues in some economic sectors since those industries can’t reach total capacity.
Still, corporate earnings were solid in the second quarter. And, quite comically, the earnings picture made the analysts’ projections look laughable and showed just how lousy they sometimes are at forecasting the future. But in defense of those analysts, these are abnormal times. Fortunately for stock market returns, earnings, for the most part, surprised greatly to the upside. As a result, US indexes kept pressing on as the second-quarter reporting cycle came to a close. Credit markets also received a stress test in September as Evergrande, a Chinese real estate conglomerate, received massive downgrades and essentially defaulted on some of its obligations. However, the risks associated with this default seem well contained inside Evergrande and its creditors, supporting the notion that financial markets are well-capitalized, just as the Fed has been saying.
Still, there are often risks during periods when stock market prices rush to new heights. Therefore, investors should set appropriate return expectations during these times when markets are trading above average norms. Moreover, price inflation is alive and well in most segments of the global economy. Energy prices are high and so are home values. For example, national home prices have increased by twenty percent over the last year. The Federal Reserve sees this as a temporary change, and they’re probably right. However, companies are starting to announce price hikes, such as Dollar Tree’s reference to an experimental two-dollar price point.
Finally, monetary stimulus and government spending have received much more attention as inflation has moved higher. As a result, the Treasury Secretary and Fed Chairman have attracted the scrutiny of the Congress, and more Federal Reserve Presidents now expect short-term rate increases to come sooner rather than later. Meanwhile, Congress continues to test legislation regarding the debt ceiling as they try to appease their districts with an upcoming spending bill that could reach into the trillions of dollars. As it stands now, the government will remain funded into December, so those that are due government payments will continue to receive their checks. Most likely, members of Congress will continue to pressure the debt ceiling while they do their best to figure out the terms of the next big spending bill.
The aggressive fiscal and monetary policies have indeed propped equity prices, which may very well continue. But because of the elevated market risks, including uncorrelated exposures against equities in portfolios is perhaps a good thing as any misstep caused by policy, financial default, or market shock could become a volatile situation. With that said, the current market and economic situation seem to be making a solid case for extensive portfolio diversification.
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