Outlook and Market Review - Third Quarter 2021

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Third quarter 2021 GDP growth was only 2.1% following 6.7% growth in the second quarter, according to the revised Bureau of Economic Analysis announcement. Most of third quarter growth came from inventory accumulation while consumer spending was unusually weak with only 1.8% growth. Fiscal stimulus in the first half of 2021 waned after the second quarter, lowering disposable income. While accumulated savings provided a buffer for consumers, inflation and an uptick in pandemic concerns weighed on spending. The Fed continued expansionary policies keeping the Fed Fund rate near zero and maintaining a large bond purchasing program. The year-over-year growth rate of the M2 money supply was 13.01% at the end of the third quarter following a 23.72% growth rate last year. The long term average growth rate of M2 is only about 7%. Is does not yet appear as if the economy can generate a strong recovery without monetary and fiscal policy support.

The labor market shows mixed strength, even though payroll expansion hit a road bump in November. The unemployment rate dipped to 4.2% in November but only 210,000 jobs were created compared to an average of 582,000 jobs per month for the rest of this year. The labor force participation rate held steady at 61.8%. The combined effect of low labor productivity and wage gains resulted in an 8.3% gain in unit labor costs. Wage gains for the year are just under 5%, but high inflation prevented gains in real wages. Consumer sentiment hit a nine-month low in November, even before the Omicron virus was discovered. Annual inflation of 6% coupled with remnants of COVID restrictions presented hurdles for most households. Overall, there is discomfort due to a lack of confidence in the ability of leadership to manage supply chain challenges, energy prices and inflation, threats to the Ukraine, tension with China, southern border security, growing national debt, crime and domestic safety, public education, and the uncertain costs and benefits of unprecedented spending packages before Congress.

The ISM manufacturing index posted two straight months with below 50 readings. While 50 is the expansion benchmark, the index only suggests weakness at this point. A key issue going forward will be the extent to which the Omicron virus leads to disruptions in the domestic and global markets. The third quarter was off to a good start until the Omicron variant and the Fed’s elevated concern for inflation came to light late in November. Retail sales increased 14.8% from last year and spending appeared robust going into the holiday season. Estimates for fourth quarter growth should be revised downward from a 5% forecast. The Fed is likely to begin tapering bond purchases in December with three expected hikes in the Fed Fund rate during 2022. As inflation estimates are revised upward, lenders are likely to increase borrowing rates, slowing the housing market and durable good spending going into 2022.

Headline inflation is likely to be lower in the fourth quarter as oil prices moderate due to lower demand linked virus concerns. Improvements in the supply chain also should eventually ease price pressures. However, inflation should track well ahead of the FED’s 2.5% target. While equity prices are currently slumping, earnings strength and a lack of alternatives for positive real returns should help prevent permanent sell offs. Cash positions are likely to increase for the remainder of this year. The yield on 10-year Treasury notes edged lower to 1.36% at the time of the writing of this Outlook.