Market Recap

The third quarter concluded at a low point as September’s seasonal weakness lived up to its reputation as the worst month for equities. As a result, the S&P registered its first drop of over 5% in nearly a year.[1] Overall, the volatility backdrop has been remarkably muted considering that the average yearly peak-to-trough decline for the S&P 500 has been -14.3%.[2] For the quarter, the S&P 500 eked out a modest .58%, while the global MSCI ACWI Index declined -1.05%.[3] US small cap stocks gave back some of their year-to-date gains, sliding -4.36% as measured by the Russell 2000 index.[4] Emerging markets were the hardest hit as the MSCI Emerging Markets Index declined -8.09% driven by continued Chinese regulatory headlines.[5]

The recent volatility is not without context given the perceived gamut of uncertainties confronting investors. COVID variants, Chinese regulatory changes, ongoing global supply chain constraints, labor shortages, fiscal policy uncertainty, and waning monetary policy weighed on the market. It all raises the question, “is the market entering a correction phase?” So, while uncertainties will always exist, our current asset allocation framework continues to support the case that seasonal weakness is temporary and is not the harbinger of prolonged weakness or an imminent economic contraction. As we noted previously, global economic momentum likely peaked during the second quarter, but remains firmly positive. The International Monetary Fund projects that global economy will advance 6% in 2021 and 4.9% in 2022. Despite moderating growth, we see a positive path for above-trend global growth and corporate profits. Overall, a supportive backdrop is in place with solid corporate and household balance sheets, ample liquidity, and a meaningful capex cycle tailwind.

Bond yields began rising during the second half of the quarter on the heels of higher rates of inflation. The yield on the 10-year US Treasury bottomed at 1.17% in August before doing an about-face and rising to 1.53% at quarter end.[6] While yields are likely to continue to rise from here, we expect both the scale and the pace of yield increases to be modest. As anticipated in late September, Fed Chairman Jerome Powell signaled that the Fed could begin tapering its $120 billion in monthly bond buying programs later this year. However, monetary policy remains highly accommodative and the pace of an eventual increase in short-term interests will likely be slower than forecasts. As a result, real or inflation-adjusted bond yields should remain strongly negative for the next few quarters.

Ongoing supply chain constraints have been a common refrain from corporations and likely contributed to the September rise in rates. The constraints caused by raw material and input shortages, along with delivery delays, continue to hinder global output. The result has been rising commodity prices and transportation costs. The surge in reopening demand has increased global supplier delivery times to a near-record level according to Ned Davis Research. The shortages and delays are obstacles that are not likely to be resolved in the short-term as the recovery extends. Capital investment and active management along with improving global COVID vaccination rates will require time for the supply chain imbalances to abate.

Overall, our asset allocation framework continues to register a positive market environment for equities and risk assets. On the surface, our preferred portfolio positioning has not changed since the spring. We continue to favor a risk-on posture relative to our strategic benchmarks with a tactical overweight to the U.S. and small-cap equities while maintaining a balanced exposure to developed non-US equities. We remain underweight traditional fixed income with an emphasis on flexible and opportunistic bond strategies. We have an overweight to credit reflecting the strong economic backdrop for the consumer and corporations. While we expect market volatility to pick up as growth moderates, we do not

anticipate a change in the overall direction. Faltering economic and corporate earnings growth remains the greatest risk to equity market returns. We believe the global supply chain challenges will be overcome and global policymakers remain committed to a supportive backdrop for risk assets and economic expansion. Until the data and evidence change course, we view any near-term volatility as healthy and an opportunity to tactically buy equities.

Tax Changes & The Market

Tax rates appear all but guaranteed to move higher, but likely by less than current proposals. Record government spending plans, coupled with historically low tax rates have set the stage for heated debates in Congress. The table below highlights the Biden administration’s initial proposal earlier this year.

Source: Goldman Sachs Global Investment Research

Historical data suggests that the stock market has typically waited to react to tax policy changes until the details are confirmed. It is worth noting that previous capital gains tax increases (e.g. 1987 and 2013) did not appear to have a material impact on the markets.

Ultimately, the tax rate changes may have limited impact on market returns but have a greater impact on how much of the market’s appreciation investors keep in their pockets. While a material increase in the corporate tax rate to Biden’s proposed 28% could adversely impact a range of industries, pundits believe Congress is likely to consider a smaller increase.

Lastly, the impact on economic growth will largely depend on how D.C. chooses to allocate or spend the increased revenue. Infrastructure spending will be far more impactful for economic growth than dropping the revenue into the general federal coffers. While the debate in Congress has continued for the better part of the year, the outcome will largely be dictated by the magnitude of final spending bills.

[1] Ned Davis Research

[2] Standard & Poor’s, J.P. Morgan Asset Management

[3] Morningstar Direct

[4] Morningstar Direct

[5]Morningstar Direct

[6] Morningstar Direct

Disclosures:

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. All investments include a risk of loss that clients should be prepared to bear. Different types of investments involve varying degrees of risk and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Economic factors, market conditions and investment strategies will affect the performance of any portfolio, and there are no assurances that it will match or outperform any benchmark. Asset Allocation may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss.

New World Advisors, LLC ("New World") is a Registered Investment Advisor ("RIA") with the U.S. Securities and Exchange Commission (“SEC”). New World provides investment advisory and related services to clients nationally. New World will maintain all applicable notice filings, registrations and licenses as required by the SEC and various state regulators in which New World conducts business. New World renders individualized responses to persons in a particular state only after complying with all regulatory requirements or pursuant to an applicable state exemption or exclusion.

Q3 2021 Market Overview