Quarterly Commentary 3Q’21
People Get Ready
When we delivered our last commentary just three months ago, things were looking relatively rosy. Coronavirus trends were improving, economists were projecting record-smashing growth for the months ahead, and markets were delivering consistently positive returns. While that story is still somewhat intact, the upward trajectory – and the carefree summer we’d longed for -- was disrupted by rapid spread of the Delta variant and growing concerns about supply chain reliability and worker shortages.
Plus, it was hot. The changing climate showed up everywhere and in some unexpected ways. Temperatures reached 116o in normally temperate Portland, OR, while floodwaters invaded New York City and western Germany, record-setting drought plagued much of California, and the wind stopped blowing offshore the UK. All of this added to the atmosphere of unease and disruption, with a new sense of urgency to act on climate change.
That urgency should make a difference as the COP26 climate talks kick off in Glasgow at the end of October, but that’s not as clear as it once seemed. With the global economic rebound, demand for energy is soaring. Meantime, the slowdown in fossil fuel production over recent years (due in part to successful pressure from climate activists) and the not-yet-adequate production of renewable alternatives has combined to create major supply constraints. The result: soaring oil and gas prices, with energy shortages in many countries, China and India in particular. In 2021 oil prices have rebounded 70% to a 7-year high of $86/barrel and conventional energy stocks are consequently up 52% year-to-date. But as you can see from the chart at right – which shows conventional and renewable energy stock performance relative to global stocks a whole over the past decade – the recent rally in energy stocks is minor in the larger scheme of things. The “rally” is represented by that last little hook on the blue line.
It’s alarming to see the world turning to increased fossil fuel production as a quick fix for this supply crunch – but it’s also increasingly clear that strategy won’t work in the longer run. The International Energy Agency chart at left shows the world’s energy future has a clear direction – but we simply aren’t there yet. All of that calls for faster & more aggressive development of energy alternatives. The US Congress is debating exactly this right now as it negotiates the level and direction of infrastructure spending. At the same time, the US will very soon be called to make commitments alongside other global powers at COP26. Months ago we may have been optimistic about the US taking a leadership role in setting greenhouse gas reduction targets. The recent energy crunch introduces new wild cards around how the talks will play out but even if COP26 disappoints, the transition away from fossil fuels is happening. We see the recent supply-demand imbalances as an indication that the world is grappling with the challenges of this transition. Change doesn’t come without bumps. Expect more ahead – but those bumps could be signals that exactly what needs to happen is actually happening.
A Bumpier Recovery
Despite the continuing disruptions from Covid, weather events, supply chains and labor markets, consumers around the world have kept spending. The global recovery story – while bumpy -- remains largely intact. Economists at the International Monetary Fund did reduce global growth projections in their latest October report but only modestly, to 5.9% globally from 6.0% in July and to 6.0% for the U.S from 7.0% in July.
The growing demand for goods and services, raw materials, and labor – especially in the face of supply challenges -- is leading to price increases across the board. The US Consumer Price Index was up 5.4% year-over-year for September, and inflationary forces now appear to be more persistent than many economists had been expecting. Still, the consensus view is that much of the growth is recovery-related – and that growth will moderate as the recovery matures. As growth softens, supply chain stress will likely ease – and all that will serve to put supply and demand back in balance with growth in a more normal range. The Federal Reserve and many economists subscribe to this view. But as we wrote last quarter, inflation can move quickly so we’re keeping a close watch.
With all these moving parts, the markets were mixed through the 3rd Quarter, starting strong but with a downward turn in September that erased earlier gains for most major benchmarks. For the full 3rd Quarter, overall returns for both stocks and bonds finished roughly flat, with the global MSCI All Country World Index returning -0.95% and the US-based S&P 500 +0.58%. The most dramatic action was reserved for the Emerging Markets index which declined (-8.8%) in the quarter, on concerns primarily related to China around distressed real estate lending and a series of increasingly aggressive and unpredictable actions from the Chinese government – we’re keeping a close watch on those developments. For the year-to-date, broad market benchmarks remain firmly in positive territory, with the MSCI ACWI up 11.5% and the S&P 500 up 15.9%. In Figure 8 portfolios, we’ve been trimming where growth has led to stock positions exceeding targets, and careful in buying bonds with interest rates so low (and bond prices so high). As a result, we’re currently holding more cash in balanced portfolios than we might be otherwise.
Our Figure 8 team often gets asked about whether we’re optimistic given the world’s many challenges: climate change, the pandemic, and politics. Depending on the day, we might answer that either way! But as investors, we can state this with great confidence: there is so much potential for humans to solve these problems. We need science, innovation, persistence, good management, and capital – every one of those ingredients -- and the great news is that our ability to tap all those things exists. If and when we do, we’ll all win.
