Q3 2021 Passionate Investor

Investment Advice Investment Advisor Investment Companies Investment Management Investment Planning Investment Strategy Investments October 22, 2021 Author: Woody Derricks

Q3 2021 Market Review and Commentary

Market Review*

  • Equity markets generally outperformed fixed-income markets with the S&P 500 rising 0.58% (including dividends; +15.92% YTD) and the Barclay’s Capital U.S. Aggregate Bond index rising 0.05% (-1.55% YTD).
  • Small caps underperformed large-cap stocks (S&P 500) as the Russell 2000 small-cap stock index returned -4.36% (+12.41% YTD).
  • Value slightly outperformed Growth during the quarter (as determined by the S&P 1500 broad market index which includes large, mid, and small-capitalization stocks).
  • International or developed, non-U.S. equity markets outperformedS. markets in U.S. dollars (MSCI EAFE**: +1.41%; +14.70% YTD) but fell 0.35% in local currency terms (+8.79% YTD).
  • The MSCI Emerging Markets Index underperformed developed, non-U.S. equity markets (international) in both U.S. dollar (-7.97%; -0.99% YTD) and local currency terms (-6.57%; +0.98% YTD).
  • S. market sectors were mixed during the quarter. Financials (+2.74%; +29.14% YTD), telecommunication services (+1.60%; +21.59% YTD), and utilities stocks (+1.78%; +4.20% YTD), were most distinguishable given their strength.  Industrials (-4.23%; +11.48% YTD) and materials stocks (-3.51%; +10.49% YTD) were notable given their weakness.
  • High yield bonds fell37% (+1.70% YTD) during the quarter. The U.S. corporate bond sector decreased 0.12% during the quarter (-2.06% YTD).  10-Year U.S. Treasury yields climbed from 1.40% at the beginning of the quarter (0.87% at the beginning of the year) to 1.46% currently.
  • The U.S. dollar rose versus the Japanese Yen (+0.53%; +8.07% YTD), the Euro (+2.27%; +5.28% YTD), and British Pound (+2.40%; +1.36% YTD).


* Unless otherwise noted, performances stated above reflect data provided by Standard and Poor’s, Russell Investments, MSCI, and Barclay’s Capital.

** The MSCI EAFE Index is a large capitalization, developed market benchmark that tracks non-U.S. or international equity markets. 


Market Commentary

S&P 500 – 3rd Quarter 2021 Performance

Source: FactSet

Stocks were less sanguine to end the quarter despite having lodged seemingly daily all-time highs up until early September and a marginal gain through its last week (the S&P 500 was down 4.97% from its quarterly high but up 0.58% for the quarter).  For most of the quarter, increased infections and hospitalization due to the COVID-19 Delta variant had led to greater investor interest in large-cap, growth-oriented stocks, and technology shares in particular.  However, inflationary concerns which dominated the news in the first half of the year returned to drive headlines as the quarter came to a close; narrowing the performance gap between large and small-cap stocks; and growth and value.  Technology stocks also trailed in the quarter’s last week as interest rates climbed in part based on inflation expectations.


S&P 500 – Trailing 12 Month 2021 Performance

Source: FactSet

Pandemic fears helped small-cap stocks fall 4.36% during the quarter.  Value stocks narrowly outperformed growth stocks despite the viral trend.  International stocks slightly outperformed US stocks in local currency but fell after adjusting for US dollar strength (see below).  Emerging market stocks tumbled considerably on an absolute basis and relative to their developed market peers.  The US bond market was flat during the quarter as 10-year government bond yields stayed essentially level (despite their climb at quarter-end).  The US dollar strengthened relative to most other currencies as global investors sought higher yields from dollar-denominated debt.


A Mea Culpa?
Investors were mildly surprised in late September as the US Federal Reserve (the “Fed”) signaled a sooner than expected end to the accommodative phase of its pandemic relief.  The Fed indicated that asset purchases that had begun as a result of the pandemic would slowly be wound down over the course of the next year (the so-called “tapering”).  Moreover, it is now expected that the Fed will also begin to raise interest rates by the end of next year.  The takeaway from the meeting was that committee members seemed more concerned about inflation than previously and ostensibly, admitted to having underestimated its impact and duration.  The Fed however did hold fast to their belief that inflation is still transitory in nature (stemming from the pandemic) and is expected to dissipate over the next year.


Are Inflation Expectations Rising?
Our readers should not be surprised by a recent Federal Reserve Bank of New York survey suggesting that consumers are already feeling the pinch of inflation and that they believe prices will continue to increase (please click HERE to read this survey).  We mentioned in our previous newsletter (please click HERE to read it again) the danger of inflation expectations morphing into a self-fulfilling prophecy.  Consumers that expect increases in the prices of the things they buy may purchase them sooner, rather than wait for tomorrow.  They may also begin to stock up on or “hoard” these goods if they believe inflation will persist.  This inflationary pressure can snowball substantially if many consumers of like mind behave in a similar fashion.  They can also exacerbate any supply/demand bottlenecks (i.e. inflationary pressure) that still exist due to the pandemic.  Inflation expectations will then have become self-fulfilling as inflationary pressure grows uncontrollably and becomes a reality.


Oh, By the Way…
For most of the quarter, the Delta variant of the SARS-CoV-2 virus was the narrative that drove stocks (at least) in the US.  Investors worried that the new mutation would impact the economy similarly to the original variant from last year.  Shares of companies dependent on normalization or re-opening of the economy took a breather from their strong run since lows in Spring 2020.  Airlines, hoteliers, cruise lines, movie operators, restaurants, energy, and retail stocks generally (companies that could be classified as being cyclical in nature, small capitalization, and/or stylistically value companies) were sold off in favor of larger companies with stronger growth profiles or those that were technology-related.  For these companies, resurfaced inflationary fears and stabilizing infection and hospitalization data served as a good distraction that allowed their depressed shares to recoup some of their losses..


A Stroll Back in Time
Perhaps it would be instructive to review another period of high inflation in the US (not that we are forecasting a similar magnitude or duration of inflation today).  Some of our readers may remember that the 1970s was a time of severe inflationary pressure with bouts of stagflation (periods of high inflation and unemployment) interspersed.  Inflation measured 7.4% annually for the decade while the S&P 500 returned only 5.8% (annually; including dividends).  The S&P 500’s “real” or inflation-adjusted return was -1.4% annually.  It was a terrible period for all investors but especially those who were retired or about to be so.

Dist. Rate
Inflation Real
Price Change
Total Return
1970’s 1.6 % 4.3 % 5.8 % 7.4 % -5.4 % -1.4 %

Click HERE for the source

The good news is that stocks have performed better over a longer investment time period.  We know that the S&P 500 has averaged approximately 10% annually since 1926 (geometric average; including dividends); it is roughly 7% after adjusting for inflation (Please click HERE for the source).  This is certainly a much better return than an investor would have experienced in the 1970s decade alone.  But there is a catch: timing is everything and the 10% market return covers the good and bad periods – including times when the market performed poorly or there were exceptionally high levels of inflation.  To actually experience a 10% return, an investor would have had to have been invested for a good chunk of that period – if not all of it.

Obligatory Plug for Our Strategy
We believe our actively managed investment strategy offers the opportunity to do better.  We do not profess to know how long or severe inflation will be.  However, we do know that during times of high inflationary pressures or when there are periods of high stock market uncertainty, there is usually also a period of severe or higher than normal volatility in the stock market.  This is where we believe our strategy can be beneficial as it generally seeks to exploit stock market volatility and inefficiency.  We do NOT make any promises, but we would hope that our performance is competitive.

There Is No Alternative
Some investors may be driven by inflationary fears to make “defensive” changes to their portfolios to mitigate its effect.  Market timing or speculation is sometimes utilized by traders or emotional investors to help them through difficult times (Please click HERE to read our thoughts on market timing).  Sometimes, other investments or asset classes offering inflation protection are utilized to mitigate the rise in prices (e.g., TIPS, derivatives/hedging strategies, public/private real estate, commodities, etc.).  We would certainly caution against these measures as we view them as speculative and short-term in nature and ultimately, a form of market timing that probably deviates from their long-term investment goals.  These short-term schemes are inherently expensive, oftentimes implemented too late, may lead to real and permanent losses of capital, and can produce severe opportunity costs.  We believe the stock market and active investing continue to be the best option for investors.


Closing Remarks
Market timing usually deviates from the actual market return and can lead to large-scale underperformance if not perfectly executed every step of the way.  History suggests it is better, easier, and far less expensive to stay invested in and committed to a long-term investment plan.  A long-term investment plan is important for those who want peace of mind and the ability to sleep at night.  We will always recommend investors “stay the course” regardless of the fear “du jour.”  It will help them minimize the real danger in investing: a permanent loss of capital.  Combine that with an offensive strategy to actually exploit these short-term stock market opportunities and we’re that much closer to achieving our goals – together.  And that is what it’s all about.  Enjoy the Autumn!

“The best defense is a good offense”

 — Unknown


Tim Hai, CFA®, CAIA®
Chief Investment Officer & Senior Portfolio Manager

Want to learn more about our Chief Investment Officer? Check out Tim’s Bio!

Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output” — Milton Friedman


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