09 Nov 2021
Third quarter GDP was gross, but…
With government spending on the decline, consumers pulling back, and supply chain issues worsening, third quarter US GDP (Gross Domestic Product) growth came in at a mere 2.0%, below the consensus estimate of 2.6%, and well below the second quarter’s 6.7% rate. Inventories were the bright spot, while trade was a net negative. However, both the consumer and corporations are expected to ramp up spending in the final quarter – and the Atlanta Fed’s GDPNow estimate sits at 8.5% as of November 4th.
As of November 3rd, 62% of S&P 500® companies had reported actual results for the third quarter. Of these, about 81% have beaten earnings estimates and 77% have beaten sales estimates, according to data from S&P. Overall, revenue per share is expected to be about flat for the quarter, which aligns with the slowdown in GDP. Margins are expected to decline modestly from 13.5% in the second quarter to about 13.3%, and there are myriad reasons to believe that this is just the beginning of a downward trend. A recent survey by Gartner indicates that CFO’s are citing multiple sources of input inflation: wages, raw materials, freight, and IT hardware, software and services.
Further, as reported by the NY Times DealBook, comments about continued supply chain woes are now quite common on earnings calls.
- G.E.: “We’re feeling the impact of supply-chain disruptions in many of our businesses, with the largest impact to date in health care,” said Larry Culp, the conglomerate’s C.E.O.
- Sherwin-Williams: The availability and cost of raw materials led the paint company to report a 30 percent drop in quarterly profit from a year ago.
- Hasbro: “Our airfreight expense was much higher in the third quarter than it typically is, and we do expect it to be higher in the fourth quarter,” said Deborah Thomas, the toy maker’s C.F.O.
Apple and Amazon also felt the sting of supply chain difficulties. Apple’s Tim Cook estimated that $6 billion in sales were lost or delayed during the quarter, and Amazon’s Brian Olsavsky said wage growth added $2 billion to costs.
The supply chain problems related to the worker shortage show no end in sight. The Census Bureau recently reported that applications for employer identification numbers required to start a business exceeded 5 million over the past 12 months, the highest level on record. That, coupled with 3 million or so early retirements from the beginning of the pandemic through June suggests that the struggle to find workers is one phenomenon that may not be transitory.
What happened in the markets in October?
- Equities: An Eminence Front
During the month, the market, in its ever so discerning way, interpreted good news as good news and bad news as good news, propelling the regnant S&P 500 to a 7.0% return. Bigger and growthier were the rewarded characteristics, and the Russell 1000 Growth finished 8.7% higher. REITs also hit it out of the park, gaining between 7 to 8%, depending on the index, and small caps gained between 3.4% (S&P 600) and 4.3% (Russell 2000). Every S&P 1500 sector was solidly in the black, with Consumer Discretionary (+10.2%) and Energy (+10.1%) leading the pack, while Consumer Staples (+3.8%) and Communication Services (+2.8%) trailed. Within the Consumer Discretionary sector, automakers rolled to a 36% gain, which just might have been linked to Tesla, now worth essentially the equivalent of every other automobile company on the planet, combined. Markets are rational and efficient though, so don’t worry…
Overseas, markets also enjoyed gains, but at a more muted level. The MSCI EAFE Index advanced by 2.5%, slightly ahead of its hedged version, as the dollar retreated a bit. International small caps were also up, gaining around 1.6%, while emerging markets returned a modest 1%, even as China, which sank emerging markets in the third quarter, rebounded by about 3%.
- Bonds: Where Have All the Good Times Gone?
The yield on the 10-year barely budged month-over-month, ending up 3 basis points (bps) at 1.55%, but the ride along the way was slightly more interesting. Regardless, the Bloomberg U.S. Aggregate Bond was flat, with investment grade corporates up around 25 bps, high yield off by about 20 bps, and municipals falling by almost 0.3%. It’s difficult to know what to be surprised about anymore, but the fact that the Bloomberg U.S. Treasury 20+ Yr Index rallied by 2.3% during a risk-on month did catch our eye.
The bond market was clearly focused on inflation and the Fed’s intentions throughout the month, and post month-end, got some clarity on the latter. As expected, Fed officials agreed to wind down their $120-billion-a-month asset-purchase program by $15 billion ($10B in Treasuries and $5B in Mortgage-Backed Securities) each in November and December, which would be on pace for a total wind down by June.1 Fed Chairman Powell also played down the likelihood of an impending increase in rates, but interest-rate futures now imply about a 75% chance of at least a half percentage point increase next year.
- Commodities: Dancing Days
Commodities as a group advanced by 2.6% for the month and the Bloomberg Commodity Index is up over 32% year-to-date, which if sustained, would mark the best year for commodities since 2000. Beneath the hood though there was substantial deviation, with lead (+15.2%), zinc (13.6%), and WTI crude (+10.7%) at the top, and sugar (-5.3%), natural gas (-9.8%), and lean hogs (-10.9%) falling out of favor (who wants a lean hog anyway?).
With energy prices surging over the past year, the rig count, according to Baker Hughes, has increased substantially, but on a price-to-rig-count basis, we are still near an all-time high. Because financing has become increasingly difficult for oil and gas companies, coupled with the haunting memory of the collapse of oil prices in the spring of 2020, producers have been slower to ramp up production as prices have risen.
How are Frontier strategies positioned?
Allocation Changes
Going into the month our allocations were largely unchanged from the prior month, a theme of late. Further, trading activity within our standard Globally Diversified Strategies was quiet (taxable models did see activity). In a world of low and compressed return expectations, amidst high valuations, major shifts are less likely to occur.
While our equity positioning exhibits slight biases toward U.S. and international small caps, as well as emerging markets within our more aggressive portfolios, our biggest overweights are to managed futures, high quality bonds in the more conservative strategies, and long-term Treasuries just about across the board. Absolute return and high yield are the areas in which our strategies tend to be the most underweight.
Performance Attribution
With U.S. large caps and REITs in the driver seat, international and emerging stocks posting positive, but less robust numbers, and high-quality bonds slightly negative, most of Frontier’s Globally Diversified Strategies trailed benchmarks by a modest amount during the month. Returns were still nicely positive, and as mentioned above, somewhat surprisingly helped by long-term Treasuries. The lack of direct exposure to high yield was also a positive.
1 Wall Street Journal, Nov. 3, 2021
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Nominal GDP measures a country’s gross domestic product using current prices, without adjusting for inflation. Contrast this with real GDP, which measures a country’s economic output adjusted for the impact of inflation.
Real Return – The annual percentage return realized on an investment, which is adjusted for changes in prices due to inflation or other external factors.
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ASSET CLASS |
INDEX |
INDEX DESCRIPTION |
U.S. Large Cap Equity |
S&P 500 |
Represents US large company stocks. It is a market-value-weighted index of 500 stocks that are traded on the NYSE, AMEX, and NASDAQ |
U.S. Small Cap Equity |
S&P 600 / Russell 2000 |
Measures the performance of the small-cap segment of the U.S. equity market. |
U.S. Equity |
S&P 1500 |
Replicates the performance of the U.S. equity market. |
U.S. REITS |
FTSE NAREIT Equity REIT |
A free-float adjusted, market capitalization-weighted index of U.S. equity REITs. |
International Equity |
MSCI EAFE |
An equity index which captures large and mid cap representation across 21 Developed Markets countries around the world, excluding the U.S. and Canada. |
International Small Cap Equity |
MSCI EAFE Small Cap |
An equity index which captures small cap representation across Developed Markets countries* around the world, excluding the US and Canada. |
Emerging Markets |
MSCI Emerging Markets |
An Index that captures large and mid cap representation across 27 Emerging Markets (EM) countries |
Commodities |
Bloomberg Commodity |
This is a broadly diversified index that allows investors to track commodity futures through a single, simple measure. The DJ-UBSCISM is composed of futures contracts on physical commodities. |
U.S. Investment-Grade Bonds |
Barclays U.S. Aggregate Bond |
Measures the performance of the U.S. investment grade bonds market. The securities must have at least one year remaining to maturity, must be denominated in U.S. dollars and must be fixed rate, nonconvertible and taxable. |
U.S. Long-Term Treasury Bonds |
Bloomberg U.S. Treasury 20+ |
Measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury with 20+ years to maturity |
Large Cap Growth |
Russell 1000 Growth |
Measures the performance of the large-cap growth segment of the U.S. equity universe. |