The S&P 500 declined by 4.7% in September to finish flat for the 3rd quarter. This was the index’s first sign of weakness since the sharp rally from the bottom in March 2020 as it has returned at least 6% per quarter going back the 3rd quarter of 2020.
S&P 500 Total Quarterly Returns 3Q20 -3Q21
|3rd Quarter 2020||+8.9%|
|4th Quarter 2020||+12.2%|
|1st Quarter 2021||+6.2%|
|2nd Quarter 2021||+8.5%|
|3rd Quarter 2021||+0.6%|
If you were just looking at the S&P 500 quarterly returns you would think that Q3 was the first quarter of volatility in US Equity markets since that low last March. However there are many segments of the market that have been flat or negative since early 2021. For instance US Small Caps (-0.15%, ticker: IJR) and Mid Caps (+0.29%, ticker: IJH ) ended Q3 near the same levels they ended Q1, and Emerging Markets were down by 6% over that same time period.
Index Returns 4/1/2021 -9/30/2021
Looking at S&P 500 returns as a proxy for the overall market can be misleading as it’s a cap-weighted index that can be heavily influenced by the performance of some of the largest companies like Microsoft (+32% ytd through Q3) and Google (+55%); and also certain sectors that have performed well like Financials (+25% ytd, ticker: ‘XLF’).
The below graphic recently shared by Charles Schwab further highlights the volatility that much of the market has experienced that you wouldn’t see by simply looking at index returns. While the S&P 500 hasn’t experienced a 10% correction since the March 2020 lows, over 91% of its constituents have with an average drawdown of 17% from their YTD highs.
These points of weakness and volatility seen in segments of the market are a direct reflection of risks facing the global economy that have been making headlines the past few months. These economic headwinds include rising inflation due to supply chain issues with both materials and labor, geopolitical concerns in China specifically around the increased regulation they’ve imposed on their tech and consumer sectors, and the chance that interest rates could rise at a faster rate than expected. The annual % change in CPI ended August 2021 at 5.3%, the MSCI China Index declined by 18% in Q3, and the 10-year treasury yield has risen by over 40 basis points since August.
CPI – YoY % Change through 8/31/2021
The risk of inflation was originally thought to be a result of covid-related shutdowns impacting the supply of materials leading to rising prices in things like automobiles and new homes. However, as we enter the 4th quarter, the mention of inflation and supply chain constraints are becoming more common in the earnings calls of some of the largest US consumer companies like Costco, Nike, and Procter & Gamble. These comments coming from an array of different consumer segments have a similar theme and indicate that the issues impacting the global supply chain may be more persistent than originally thought.
There are certainly reasons for optimism as unemployment continues to fall, the operating profit margins for S&P 500 companies set a record in Q2 at 13.54% (source: Reuters), and overall growth numbers have been strong as the economy continues to reopen with real GDP increasing at an annual rate of 6.7% in Q2. However, it will be important for investors to monitor the risks facing the global economy, and how the potential for rising cost of materials and labor may impact corporate earnings, overall growth, and equity valuations that are already at historically high levels.
Andrew Gibson, CFA
Related article links:
The posts expressed are views of FSTC and are not intended as advice or recommendations. For informational purposes only. FSTC does not offer tax, legal, or investment advice, professional counsel should be sought for tax or legal advice.