SO FAR, A GOOD RECOVERY

With the third quarter of 2021 already in the rearview mirror and with an excellent Q3 Earnings Season, we wanted to summarize our market perspective for the year-end of 2021 and discuss the most relevant topics moving forward, their potential effects on your investment portfolios, and some guidelines to help you navigate them.

US ECONOMY: ON THE COMEBACK TRAIL

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From a macroeconomic standpoint, the US economy is in a recovery phase, and, is doing good. GDP grew +6.3% in Q1, +6.7% in Q2 and expected to be +2.0% in Q3. Year-over-year growth for 2021 is expected to be +5.7%.

Unemployment has gone down significantly since the start of the Pandemic, current unemployment rate is at 4.6% (Oct 2021) versus a 15% unemployment during the Mar-Apr 2020 period. In addition, demand for goods and services is so high that companies cannot keep up with their current offer.

Notwithstanding the good news, the last quarter of 2021 started with several factors to take into consideration. Today, the US Economy, specifically the Federal Reserve, is dealing with a recovering economy with some "health-related" symptoms, such as inflation, supply chains bottlenecks, labor shortage, and geopolitical risks.

TAPERING & INTEREST RATE INCREASE. THE FEDERAL RESERVE PLAYBOOK AND ITS IMPACT

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From an investor perspective, the Federal Reserve monetary policy is one of the most relevant factors to take into consideration. As the entity responsible for US economic health, the Federal Reserve must manage current financial pressures and expectations while preparing and executing a playbook of strategies to keep the US economy under control.

To be ready to raise interest rates -which are expected in 2023- the Federal Reserve started the tapering process of its Quantitative Easing program (designed to help the economy recover during the Pandemic). To do so, they will start to reduce their assets from 120 billion per month to zero, progressively reducing market liquidity as we were accustomed.

Tapering started in November 2021. Currently, the pace is set to reduce by 15 billion per month.

From a risk perspective, we can expect some market volatility. Still, given the Federal Reserve dovish approach, the market might already assume it will be done slowly and accelerate progressively until it finally reaches zero. A market tantrum can occur, but so far, the market is just adjusting as it comes, and some volatility has shown -slightly- its face during last September.

Investing while expecting an adjustment in monetary policies is always challenging, with volatility and potential market tantrums, but in the end, it is a necessary evil for a healthy economy. It is essential to remind investors of the long-term view of the investments and your objectives in these situations. To minimize the potential effects, a review with the financial advisor of your bonds & stocks positions is always recommendable, focusing on reducing portfolio duration and reconsidering any speculative investments.

THE “NOT SO TRANSITORY” INFLATION. RISKS AND DEALING WITH IT.

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The annual inflation rate in the US edged up to a 31-year high of 6.2% in October of 2021 from 5.4% in September and above market expectations of 5.8% year over year. Inflation will likely continue to remain high through 2021 and during part of 2022. Recent increases in energy prices will also keep inflation from falling more rapidly over the winter months. However, the intensity and momentum of month-over-month price increases will likely moderate over the coming months.

Inflation translates to an increase in costs. For regular people, the cost of food, housing, transport, and services increases. For companies, the cost of raw material, transportation, and labor increases costs, therefore, affecting the company's bottom line. For an investor, a company with reduced margins is not as attractive as before, affecting its value. And finally, for the Federal Reserve, a high "not-so-transitory" inflation can translate in an accelerated use of its mandate to intervene and use its powers to reduce inflation, therefore, affecting interest rates.

As of the start of the Q3 earnings reports calendar, several public companies have communicated that those inflationary pressures are more structural than transitory, consequently advising a price increase in their services and products in the short term. Interesting will be whether the consumers will be capable and are willing to absorb these increases. So far, they have done so.

From an investor perspective, stocks behave better than bonds in inflationary pressured markets. Investors should overweight quality stocks with good current returns versus future cash flows; revise speculative investments and those that depend on cheap financing. It is also recommended to consider market sectors' ETFs and mutual funds to reduce individual stock exposure and manage some volatility risk.

CHINA’S “COMMON PROSPERITY” AND ITS ECONOMIC SLOWDOWN

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Last quarter we saw China government targeting the private sector through President Xi Jinping's bold reforms, as known as "common prosperity. " Xi's reforms are a mixed bag of geopolitical control initiatives and economic reforms aimed at reducing the economy's reliance on property and debt, thus focusing on creating a more "socialist" economy while reducing the political influence of Shanghai and Zhejiang.

During the third quarter of 2021, the world's second-largest economy GPD grew by a weaker-than-expected 4.9% over a year ago, down from the previous quarter's 7.9%. This slowdown has prompted warnings about its possible shock and contagion to other economies.

Today China is facing a meltdown in the real estate sector (i.e., The Evergrande case), putting pressure on their financial system. Additionally, a chronic power shortage, thus affecting industrial production and factory output; a very restrictive ordinance because of Covid-19, limiting workforce and consumption; and lastly, a crackdown on public companies managed by influential private figures. All these have come to play in the last quarter's slowdown.

The consequence of this slowdown adds to pressure on China's government to prop up activity by easing borrowing controls and increase in public works spending. But forecasters said even if that happens, activity will continue weakening before policy changes take effect. So far, no significant shifts have been taken by China to address the slowdown, and its implication to the world economy is yet to be seen. We can expect China will not be growing as fast as it used to be, setting a more modest and flexible growth target of "above 6%" and more control over the distribution of its wealth.

On the positive side, exports have beaten expectations with a 27.1% growth year-over-year, (October 2021)accelerating from a 25.6% rise in August amid solid global demand; and the labor market seems to be healthy with an unemployment rate of 3.88% of September 2021.

From an investor perspective, investing today in China comes with considerable uncertainty. We recommend revising all Chinese positions of our portfolios and seeking a less volatile alternative, at least until some of the issues mentioned before are under control. Investing in Emerging Markets ETFs could be an attractive approach if you want to invest in China without being completely exposed to the country's volatility.

GLOBAL SUPPLY CHAIN BOTTLENECKS. A SHORT-TERM PROBLEM?

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Another factor contributing to inflation and economic slowdown on a global scale is the supply chain bottlenecks we are currently experiencing.

Problems like limited port activity, increased freight rates, lack of containers' availability, shortage of truck drivers, and chronic semiconductor chip scarcity are supply chain consequences of the Pandemic's disruption on the global economy.

All these problems are affecting growth perspectives. For example, China reported its third-quarter GDP grew a disappointing 4.9% from the previous quarter, with supply chain issues contributing to the slowdown in economic activity. Similarly, companies like Apple have announced that they might reduce between 5 to 10 million units from the 143 million units of its iPhone 13 model for the second half of 2021; nevertheless, Apple is well-positioned for solid sales.

In general, supply chain disruptions and higher input costs seem likely to be relatively transitory but noteworthy enough to continue monitoring. From an investor perspective, a rise in costs will generally have the most significant impact on low-margin companies, which tend to be found in the transportation, retail, construction, and automotive sectors. Companies that should be least impacted are those with wide profit margins, limited raw material costs, and small workforces. That should include economic sectors such as software, health care, and financials.

COVID-19 FROM EPIDEMIC TO ENDEMIC

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The Covid-19 virus will be around us for a long time. The question is when it will become an endemic disease.

In the USA, the path to becoming an endemic disease has been a rocky one, with four waves of outbreaks, massive vaccination, misinformation, and a percentage of people reluctance to get vaccinated. All these play a part in the vital goal of getting close to herd immunity to protect all of us as a society. So far, the USA is headed towards that goal, 67% of the total population has been vaccinated (at least one shot), and more than 47MM total cases have been reported since the beginning of the Pandemic. The next step will be vaccines for the younger population 12 and under.

Even though we are not yet there, the US is on the correct path. There's always the possibility of a new variant and a new outbreak, but so far, we have learned how to deal with the Pandemic, and eventually, we will treat it as an endemic disease.