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Economic Backdrop

While the overall trend in the economy continues to be positive, the rate of growth is slowing. The Conference Board’s monthly Leading Economic Index (LEI) continued to trend higher in the third quarter, although the year-over-year percentage change in the index has continued to trend lower.

The U-3 unemployment rate has continued to drop albeit at a slower pace than previous months. The U-3 rate is the most basic of the unemployment measures, as it only looks at people actively seeking jobs. The U-3 rate excludes part-time and discouraged workers who have stopped working, but it does provide a quick view into the health of the employment situation.

The Conference Board’s Employment Trends Index (ETI), which aggregates eight leading indicators of employment, dipped slightly in its September reading. A quote from the press release, “The chief culprit behind lagging job growth has been the summer surge in COVID-19 infections associated with the Delta variant. Spending on—and hiring in—in-person services significantly slowed in recent months. With new cases now trending downward, the risk of infection seems poised to decline over the rest of the year but remain significant. Thus, we expect more risk-averse consumers to continue to spend less on in-person services than they did pre-pandemic.”

Overall, while employment appears to be slowing down, there are still tailwinds that are supportive of a positive picture moving forward.

  • US jobs openings are at record highs, indicating demand for labor.
  • The US quits rate is at a record high, indicating workers are more confident in their ability to find work, which tends to be more prevalent in a strong economy rather than a weak economy, when workers lose confidence and focus on keeping their jobs rather than changing them.
  • The delta variant rough patch seems to be subsiding, which should bring more workers back into the labor force.

Market Returns

While most broad market indices have posted strong performances in 2021, the third quarter was weak overall.

From a factor perspective, value remains on top across all company sizes.


As discussed in a previous post Pain in the Bond Markets, the bond market experienced a painful first quarter. In 44 years of the flagship index, the Bloomberg Barclays U.S. Aggregate Bond Index, this was the second worst start to a year ever recorded. The silver lining based on historical precedence is that forward returns tend to be positive. While the second quarter showed a strong rebound in performance across various bond asset classes, the third quarter was mostly flat.

The chart below shows the returns of various bond asset classes. Note that they are ranked from least-to-most correlated to the stock market (S&P 500 Index). This is useful as most investors view bonds as a ballast to their stock allocation, providing protection during bouts of stock market volatility.

Looking Ahead

As we mentioned in our second quarter post, “high market valuations and milder than usual volatility year-to-date may warrant some caution.” September finally saw market volatility begin to pick up, with the S&P 500 Index declining 4.65%. Interestingly, traditional offsets to falling stocks such as Treasuries and gold did not perform well either, declining 2.85% and 3.97% respectively. We expect volatility to calm once a number of uncertainties resolve themselves, including the debt ceiling, the passing or not passing of the infrastructure bill and Biden’s larger fiscal bill, plus the renomination or replacement of U.S. Central Bank Chief Jerome Powell.

We also noted previously that the “direction and level of inflation remains the elephant in the room.” Inflation indeed has come in stronger than many anticipated, and the transitory narrative appears to be weakening. Charles Schwab’s quarterly chartbook provided some great charts and insights regarding inflation.

  • The increased demand post-Covid coupled with supply constraints appears to be the driver of increasing inflation. However, pent-up demand is not necessarily permanently higher demand.
  • While current inflation figures are high, current future inflation expectations are falling, as seen in the Inflation Swap chart below. An inflation swap is a transaction where one party transfers inflation risk to a counterparty in exchange for a fixed payment. An inflation swap can provide a decent estimation of what would be considered the “break-even” inflation rate. Inflation swaps are used by financial professionals to mitigate (or hedge) the risk of inflation and to use the price fluctuations to their advantage. If expectations were for higher inflation, the line in the chart would be upward sloping to the right rather than down.

Source: Bloomberg, USD Inflation Swap Zero Coupon Curve (SWIL). Data as of 9/30/2021.

  • The danger with inflation expectations is if higher inflation expectations were to materialize. If the expectation of rising inflation were to become ingrained in consumers, they would likely change their behavior by pulling their purchases forward to avoid higher prices in the future, thereby creating a cycle of ever-increasing inflation. As the chart above shows, this is not currently happening.
  • Inflation is difficult to predict, as many factors come into play. As shown in the chart below, correlations of inflation with what are commonly considered causes of it have changed throughout time. The positive correlations to unit labor costs have decreased, while government borrowing and increases in money supply appear to have almost entirely decoupled from inflation.

  • As seen in the chart below, the current bout of inflation has been primarily driven by an increase in energy prices, which are commodity based. There is an old saying in the commodities market that “nothing cures high commodity prices like high commodity prices”. The reason for that is that high commodity prices incentivize producers to over-produce and flood the market with too much product, which then ultimately pushes down prices. While producers attempt to be discipline and keep production levels at a sustainable level, the temptation for quick profits usually proves irresistible. Currently, some of these downward forces are being offset by supply chain issues, which may prove temporary.

Source: U.S. Bureau of Labor Statistics. Consumer Price Index for All Urban Consumers (CPI-U) and selected categories. 

In conclusion, inflation bears watching, as it will be an important driver in how various areas of the stock and bond markets perform. The chart below details how certain metrics have performed at different levels of inflation. The quick takeaway is that both GDP (the economy) and the stock market (S&P 500) perform worse the higher inflation is. The more nuanced view is that past episodes of high inflation had idiosyncratic elements to them. The pandemic that the world experienced in 2020 and in many ways is still experiencing has few historical precedents, especially considering the hyper-connected globalized world we live in today. Pre-1960s, inflation was much more volatile, as was the overall economy. Recessions were more frequent back then than post the 1960s. Excluding the period of high inflation in the 1970s, post-1960s has seen relatively lower inflation and less recessions. It will take a few more quarters to see if this bout of inflation is indeed transitory or something more enduring.



General Disclosures: The content contained in this article represents the opinions and viewpoints of Cardan Capital Partners only. It is meant for educational purposes and not meant for consumer trading decisions.  All expressions are as of its publishing date and are subject to change.  There is no assurance that any of the trends mentioned will continue in the future.  Market performance cannot be predicted, so nothing in our commentaries is ever meant to provide any kind of trading advice or guarantee of future results.  Certain information contained herein has been obtained from third party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed. Any reproduction or distribution of this presentation, as a whole or in part, or the disclosure of the contents thereof, without the prior consent of Cardan Capital Partners, LLC, is prohibited. Investments in securities entail risk and are not suitable for all investors. This is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.





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