By Tim Courtney, Chief Investment Officer
The first three quarters of 2021 have generally fallen right in line with what the market hoped to see, including record-breaking earnings,1 strong economic growth2 and improved consumer spending.3
As the fourth quarter begins, there are three developments we’ll be watching that could greatly influence market performance:
1. Inflation/rates: One area the market has been behind the curve on this year is inflation. It was expected to be elevated, but the numbers have been higher and longer-lasting than the Fed anticipated.4 So we’ll be closely watching inflation, especially in the labor market, in the fourth quarter and what it does to interest rates.
Interest rates have remained stubbornly low, although they did rise a bit toward the end of the third quarter.5 These low rates have led to borrowers utilizing more debt and leverage, which in turn has created a competitive housing market unlike anything we’ve seen in our lifetimes.6
We would expect rates to rise to reflect the economic growth and price increases we’re seeing across the economy. The sooner the Fed reduces its impact in market pricing, the better for holders of cash and bonds.
2. Potential tax law changes: Discussions about tax law changes, which were expected much earlier in the year will be likely starting in earnest in the fourth quarter. It appears that corporate tax rates are increasing and this, along with new proposed minimum corporate rates,7 will detract from company earnings. Increases in corporate tax rates will likely cause some market movement, but we don’t think what has been discussed this far will fundamentally alter the trajectory of earnings growth over the next couple of years.
What may be a bigger tax law change is on the personal side of the tax code.8 There have been discussions about taxing some capital gains as income, adding surtaxes for high earners and removing the step-up-in-basis provision. We may see certain investors needing to reposition their portfolios before higher rates take effect. Please call your advisor if you have questions about how this may affect your situation.
3. Spending bills and debt ceiling: This is where the market will likely be focused in the coming days and weeks. Markets have behaved erratically in the past when government default looked like a possibility. We expect this to be resolved, but as we get closer to the debt ceiling without resolution, market volatility could increase. We’ll know more in the next few weeks and think the proper solution is to maintain a diversified portfolio and ensure it is balanced close to your targeted allocation between stocks, bonds and cash.
We believe that economic growth and momentum will carry into 2022, with positive expected returns and continued above average earnings growth. We’ll be watching these items especially to see what impact they may have on markets and asset valuations. As always, if you have any questions, please don’t hesitate to contact your advisor.
- Trading Economics (9/24/21) — United States corporate profits
- Statista (9/10/21) — Annualized growth of real GDP in the United States from 2011 to 2021, by quarter
- The New York Times (4/29/21) — What drove the first-quarter economy: spending on goods.
- Forbes (8/18/21) — Inflation surge to continue: Here are 3 reasons why
- U.S. News & World Report (9/22/21) — Fed holds steady on interest rates but shaves 2021 economic forecast
- The Philadelphia Inquirer (8/31/21) — U.S. home prices soared at a record pace in June
- Tax Foundation (2/24/21) — Evaluating proposals to increase the corporate tax rate and levy a minimum tax on corporate book income
- Forbes (9/3/21) — Capital gains tax hike and more may come just after Labor Day
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