Growth
Real GDP expanded at a 2% annual rate in 3Q21, lower than the 2.6% consensus estimate and a sharp slowdown from robust gains earlier in the year. Weakness was led by a marked deceleration in consumer spending, growing just 1.6%, along with slower home building and a wider trade deficit. Weaker auto sales alone detracted significantly from GDP, and the rotation to services continued at a slower pace. While supply chain issues may persist well into 2022, recent data confirms economic momentum is beginning to pick up. The October ISM PMIs shaped up better than expected. Manufacturing fell less than expected to 60.8, while services rose to a new all-time record at 66.7.
Jobs
The October jobs report was stronger than expected, with non-farm payrolls increasing by 531,000 and solid upward revisions to the prior two months. Jobs gains were broad based and led by a 164,000 increase in leisure and hospitality. The unemployment rate ticked down to 4.6% from 4.8%, but labor force participation remained unchanged. Wage gains were robust, +4.9% y/y, as employers continue to compete amidst tight labor availability. Notably, faster hiring in sectors worst-hit from supply chain woes, such as the manufacturing and transportation sectors, point to some lessening of these bottlenecks in the months ahead.
Profits
The 3Q21 earnings season has been strong, with 463 companies reporting (90.5% of market cap). 81% of companies have beaten on earnings expectations and 68% have beaten on revenue expectations. Our current estimate for 3Q21 earnings is $52.12, which represents y/y EPS growth of 37.6% and a modest q/q growth of 0.2%. Earnings have held up better than we previously anticipated, as companies seem able to defend profit margins despite higher input prices. Oil (+73.4%) and the U.S. dollar (-1.4%) have also been decent tailwinds to earnings.
Inflation
Inflation has well surpassed the FOMC’s 2% target, with the headline PCE price index rising +0.3% m/m and +4.4% y/y in September. The core PCE deflator also rose to +0.2% m/m and +3.6% y/y. The October CPI report showed consumer prices rose at their fastest pace since 1990 as supply chain issues showed little signs of abating. Headline CPI came in well above expectations at +0.9% m/m and +6.2% y/y, while Core CPI rose 0.6% m/m and 4.6% y/y. Further increases in shelter costs and an acceleration of inflation across a broad range of sectors point to the continued impact of supply chain shortages and a pickup in stickier components of inflation.
Rates
At its November meeting, the FOMC officially announced its plans to taper its net asset purchases by $15bn per month beginning in mid-November. The statement language was somewhat optimistic, acknowledging the slowdown in economic activity, but also that the delta wave is receding. Notably, the Fed appears to be putting a bigger emphasis on reaching maximum employment as a necessary condition for rate hikes. As such, it’s important to note that tapering is not tightening, and while purchases will slow in the months ahead, the balance sheet will continue to expand until settling at about $9tn by mid-2022.
Risks
- The delta variant and global vaccine delays could slow the economic reopening.
- Inflation could spike in the medium term.
- Extremely accommodative monetary and fiscal policies could lead to a boom-bust recession.
Investment Themes
- U.S. equity investors may use earnings as a guide in a rising rate environment.
- Fixed income investors may underweight bonds and maintain short duration in a rising rate environment.
- Long-term growth prospects, a falling dollar and cyclicality support international equities.
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