The U.S. equity markets have been grinding higher all year, but the S&P fell roughly 4% in September making this month the first real hiccup of 2021. Stocks initially fell after China’s second-largest real estate developer China Evergrande came under pressure by failing to meet their debt obligation. The selling pressure continued after the Federal Reserve released plans to reduce its bond buying and begin raising short-term interest rates in 2022. The Bloomberg Aggregate Bond Index was flat during the quarter as the 10-year treasury yield rose from an August low of 1.20% to 1.50% to end the quarter. Rising yields mean lower prices and continued pressure on fixed income which has been a constant theme of the year.
Despite the weakness we experienced in September, we continue to believe U.S. equity markets will perform well over the coming quarters. We also expect volatility to increase as stimulus measures ease. The U.S. consumer is healthy and company balance sheets have weathered the pandemic in good standing. As mentioned in our last quarterly update, we expect bond markets to struggle as interest rate begin to normalize from historically low levels.
We will be watching international stocks closely after ending the quarter down roughly -3%. International stocks are relatively cheap compared to U.S. stocks, but recent concerns out of China have given us reasons to reevaluate their attractiveness. In addition to the issue surrounding Chinese real estate development companies (Evergrande), the Chinese government has come out with several new regulations cracking down on businesses to promote “common prosperity.” These regulations will likely slow China’s growth which could spill over into other major economies dependent on China.
Inside client accounts, we have reduced exposure to emerging market stocks to account for uncertainty surrounding China and related countries. We also continue to shift from growth stocks to value stocks which should benefit as the economy normalizes following COVID-19. In our bond allocation, we continue to reduce our exposure to rising interest rates as we look for alternative strategies.
We remain cautiously optimistic about future growth over the coming quarters with our eyes on company earnings, interest rates, and China as we enter the 4th quarter. Given the amount of cash in the market, low interest rates, low taxes and continued post-COVID expansion, we feel confident that we will continue to be rewarded for owning quality stocks.
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