Volatility in the markets increased during the third quarter as fears rose that soaring Covid cases could slow the economic rebound we have been experiencing for the past year and a half. Consumer confidence numbers took a nosedive in September, and with consumers accounting for two thirds of U.S. economic activity, worries have risen that we are facing economic headwinds. In addition to the potential of a slowing economy, the increasing fear that inflation might be getting out of hand has also weighed on investors. It is an interesting time right now and economic and market uncertainty is climbing.
The economic recovery in the U.S. since the lockdown of 2020 has been quite remarkable. Last year’s recession was short but very severe. While we can always debate the level of Government stimulus necessary in times like this, there is no denying that flooding the economy with money helped bring us back to growth. The question now is when to end the stimulus and how to ween the economy off Government spending.
Current economic data is a mixed bag. New job growth continues to be impressive, with gains across the economic spectrum. However, inflation over the past twelve months is running higher than at any point in the last thirty years. The Fed maintains that this inflation is temporary, but many economists disagree. This will be something that almost everyone will be keeping their eyes on as we move forward.
Maintaining economic stability is one of the responsibilities of the Federal Reserve. Using a number of fiscal and monetary strategies at their disposal, the Fed tries to keep the economy growing while making sure it does not grow so fast that we get inflation. This is a very difficult job, and they have been quite successful at it over the past forty years or so. However, there is often political pressure placed on the Fed for them to extend their influence to taking action to keep the markets rising. This is beyond the scope of the Fed. Markets rise and markets fall, it’s what they do. Taking action to artificially keep stocks high ultimately lead to bigger problems in the future. The stock market must be allowed to drop. Pullbacks in the markets keep them healthy and prevents bubbles from forming. By almost every measure of valuation, the stock market today is nearly at the levels only seen during the height of the dot com bubble in the late 1990’s. Free and easy money from the Government is helping to push stocks higher, even with little underlying justification.
The U.S. economy is in remarkably good shape given what we have had to deal with over the past eighteen months. We feel that the stock market is over valued at current levels and there is more downside risk than upside potential. That doesn’t mean we sell all our stocks. It means that we are currently lower weighted to stocks than normal, and we believe there will be a better time to increase stock exposure in the future.