By Megan Horneman. © Verdence Capital Advisors
- Supply chain could be threatened by China shutdowns.
- Service inflation taking over from the goods inflation.
- Federal unemployment benefits need to expire.
- Taper tantrum and seasonality pose a risk to equity market rally.
- Geopolitical risks emerge in Afghanistan.
There are many headlines today that may have unnerved investors a year ago. However, the MSCI AC World Index posted its 49th record high for the year last week, and every central global equity region is positive year to date. With that being said, it is crucial to monitor the risks the market may not be reflecting consistently. Below are risks we are watching from an economic, political, market, and geopolitical perspective.
- Economic risks – Supply chain: We have seen the broad effects of closing ports on the global supply chain. Recently, China has been forced to partially shut down some of their busiest ports, potentially putting more pressure on the supply chain.
- Economic risks – Inflation: Transitory inflation has moderated with lumber prices down around 70% and airfare prices dropping in July. However, as people switch from spending on goods to services, the Producer Price Index shows a rise in service inflation and transitory goods price inflation moderates.
- Political risk – Policy error: One of the leading factors to shortages in the labor market has been the extraordinary unemployment benefits. The extra Federal benefits are expected to expire in September. However, if the Biden Administration extends these, it may continue to hurt the labor market.
- Market risks – Taper tantrum: The fixed income market is the most overvalued area of the market. Bond yields stay stubbornly low even with the improving growth and high inflation environment. However, typically interest rates swing in one direction or the other. Right now, we see the risk of a rapid move higher, especially as the Fed confirms their plans to reduce nontraditional monetary policy.
- Market risks- Seasonality: As we move into the fall months, we are entering into a seasonally weak period for the S&P 500. Since 1945, the S&P 500 has seen its worse performance of the calendar year in September. However, 2021 started at an advantage as the S&P 500 had its best start to a year in over 20 years, so it’s not unbelievable to see investors take profits after returning from the summer months.
- Geopolitical risk – Middle East instability: Since the U.S. withdrawal in Afghanistan, the Taliban has quickly taken control, and the Afghan Government has left the country. The takeover presents a humanitarian crisis not only for Afghanistan but neighboring countries like Pakistan as well. The situation poses a renewed source of volatility in the overly optimistic market sentiment.
The Bottom Line: As equity markets make new record highs, continue to determine the risks that the market might not be reflecting. From an economic perspective, the strains in the supply chain and inflation pressures will likely stay prominent for the coming months. In addition, yields at current levels, given the growth and inflation environment, are unsustainable. We have witnessed how interest rates swing violently in one direction or the other, and the risk to the broad market would be a rapid rise in interest rates. Moreover, with seasonality is also a major concern, the geopolitical situation is quickly deteriorating in Afghanistan and should be monitored closely.
This material was prepared by Verdence Capital Advisors, LLC (“VCA”). VCA believes the information and data in this document were obtained from sources considered reliable and correct and cannot guarantee either their accuracy or completeness. VCA has not independently verified third-party sourced information and data. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. These projections, market outlooks or estimates are subject to change without notice. This material is being provided for informational purposes only and is not intended to provide, and should not be relied upon for, investment, accounting, legal, or tax advice.
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By Megan Horneman