Markets appear to be back on track after a brief bump in the road during the month of September. As of Friday's close, the S&P 500 sits just 1.3% below its all-time high. The rebound comes as the U.S. turns the corner on the delta variant. Covid is being reined in by vaccinations, natural immunity, and a growing list of treatment options. As evidenced by improving trends in leisure and retail employment, we are beginning to see a resurgence in industries hit hardest by the virus. The reopening trade has come back strong in the early days of October.  

Still, the U.S. continues to grapple with extreme disruptions to supply chains and an unprecedented shortage of labor. As such, it has been tougher sledding for the manufacturing sector. However, the pro-cyclical message from the market in recent weeks may be an indication that the supply chain and labor troubles are well known and largely priced in. Peak logjam would be most welcome in a world where rising prices have the potential to eat into consumer confidence. For now, consumer spending remains robust, but could soon slow should prices continue to surge.  

There is no doubt that the supply and labor situation is dire. The stories of sitting cargo ships, desperate employers, reluctant workers, and hot commodity markets are widespread. For some time, our position has been that inflation is likely to run hotter than we are used to over the next several years as these issues persist. We see this in rising market-based inflation expectations 3 to 5 years out. However, 10-year inflation expectations remain anchored near-normal levels around 2-2.5%. This supports our narrative of higher but not runaway inflation. We believe the cyclical pivot in the market is consistent with this thinking.  

The market will likely now be turning its attention to third-quarter earnings reports. Expectations have been quite modest going into the season, but the banks look to have us off on the right foot. Most of the banks beat on the top and bottom line as they saw more reserve releases and strong performance from their lending, trading, and investment banking departments. This lends confidence to the notion that the economy remains on stable footing. 

As we said, manufacturing may be a different story, and we'll find out more as these companies release results. However, manufacturing represents a much smaller portion of the overall economy today compared with years past. We believe it is much more important that the consumer remains healthy. Right now, we have no reason to doubt that this is the case, but we must continue to keep a watchful eye on the pace of inflation.  


Preston May, CBE®
Research Analyst


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