We welcome Autumn, as the humidity and heat of summer give way to cool crisp air, clear skies, and the changing colors of the leaves. I have always appreciated this time of year. I remember, and still enjoy, harvesting my favorite items in the garden after a long summer of work – apples, sweet potatoes, and the second round of raspberries and blackberries. It is one of the reasons I named the firm Harvest. It represented the reward of hard work, and the wisdom of saving enough for next year’s planting – which by the way starts next month with garlic.
If only the U.S. economy was as straight forward as my garden. If you have tried to purchase goods recently, you realize it can be “hit or miss.” The semiconductor chip shortage, seemingly innocuous, is just one example of how a small hiccup in the supply chain can have a rather large domino effect. We saw a huge jump in demand this year as people renovated their homes, built home offices, and found ways to spend money that didn’t include entertainment and travel.
While three months ago we anticipated supply-chain disruptions would be short-lived, we are coming to understand the issues are deeper than what the data originally showed. With the expiration of additional unemployment benefits, we should start to see some easing as people return to the labor market, although in the near-term this remains an issue for many businesses. We now think the resolution of supply chain problems may take another six to nine months.
Additionally, these issues have exposed vulnerabilities in the U.S., including just-in-time production, reduced inventories, and a significant lack of truck drivers, which could worsen over the next few years. This will lead to higher wages and inflation, which will lead to higher input costs for businesses. We are watching these supply chain risks closely as they may affect areas such as energy and sales this coming Christmas. Some sectors will be more adversely affected than others. A silver lining is that we do not expect a substantial reduction in profit margins because of productivity enhancements made by business during the last 1 ½ years. In fact, profit margins are near a 10-year high as revenues increase along with input costs.
Looking ahead, the data continues to show an economy that is resilient and growing. However, we expect growth to decelerate over the next nine months consistent with a return to normal trends. Because of the explosive economic growth in the first half of this year, the markets are fully valued going into the fourth quarter. We should expect volatility to remain with us as the markets find sustainable, higher highs in line with future earnings. On the fixed income side, interest rates have been climbing recently with the yield on the 10-year Treasury back above 1.50%. While increasing yields potentially means more income, it also means negative returns for those who hold fixed income. You can see this relationship in the iShares Core U.S. Aggregate Bond Index (AGG) which is down 1.67% for the year. Going forward, fixed income will become more of a challenge as rates continue to rise. However, we have added positions for protection that should benefit in a rising interest rate environment, and have outperformed the core bond index this year.
If you would like to discuss any of these areas in more detail please reach out to us. As always, thank you for your trust.
Marc Henn, CFP®