There is no doubt that September 2021 was a negative month for equity returns. There was little that seemed to work well for investors in the month. Depending on your views, this can be a good or bad sign. Since there is no shortage of opinions offered, possibly the sanest way to approach this is to look at what data is telling us.
A fact that most investors understand is that markets do not go up indefinitely without corrections. At times when we have pullbacks it is not a bad idea to begin to ask questions about whether we are likely to have a short-term pullback versus a longer-term pullback.
To begin to understand this, we should examine normal stock market and economic cycles. Early expansion is where the most extreme and thrilling positive returns are often obtained for investors. As the economic cycle begins to mature, the possibility for large market corrections, or even shallow bear markets, become possible. Therefore, the types of investments that are very good during the early cycle tend to begin to underperform.
In early cycles, small-caps, low quality stock, financials, industrials, materials, and non-dividend payers tend to outperform. As a cycle matures, we historically begin to see large-cap stocks, high quality stock, utilities, consumer staples, health care, and dividend stocks begin to outperform. None of these are universal truths but it has a lot to do with unemployment, monetary policy, and market sentiment.
The monetary policy that is popular these days is that of a hyper-active supporting Federal Reserve. This began in 2008/2009 and the first taper-tantrum was in 2014. During the runup when taper-talk was happening but prior to the taper beginning, early-cycle performers, outperformed defensive sectors. However, once the taper began, there was a very strong shift to defensive sectors.
Chart: Here is a table from NDR that illustrates the 2013 and 2014 pre-taper and taper performance by sectors. Chart Source: Ned Davis Research Group
It is very possible that this time markets behave similarly. The market certainly seems to be behaving in a similar pattern to this period as the Fed begins to get investors ready for the beginning of tapering at the end of 2021. However, the notable difference this time is that markets are still very much affected by the COVID pandemic.
COVID can have several influences in the short term. It is possible that as COVID case numbers begin to drop again, reopening, and cyclical value stocks could rally again. However, the effectiveness of these trades will begin to be outweighed by the pressures of a mid-cycle rotation in leadership towards more defensive sectors.
We remain optimistic for the 4th quarter. However, risks should be noted, and we are watching for continued developments with Fed tapering, inflation, and COVID. These themes will likely continue as we approach the final months of 2021.
Investment Advisory Services offered through Trek Capital Management LLC., an (SEC) Registered Investment Adviser.
Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed, and past performance is no guarantee of future results. For specific tax advice on any strategy, consult with a qualified tax professional before implementing any strategy discussed herein. Trek 21-106