Back in August we wrote about some of headwinds to economic growth for the remainder of the year. The list was short and included some of the usual suspects: virus, Federal Reserve tapering, higher taxes, labor shortages, and parts shortages. However, since August the list has not only grown in length but has also morphed into what I would call a worry list. Indeed, despite the 4% pullback during the month of September, the stock market has thus far held up well given the challenges currently facing the global economy. Here are some of the new additions to the list of worries list.
1. Evergrande
Evergrande, a company that few Americans had ever hear of, has become major concern for the global economy. Evergrande is the largest real estate developer in China and one of the largest issuers of debt in the world, with more than $300 billion of debt outstanding. The company announced that it would not make some of its payments in September, setting the stage for a massive debt failure or restructuring. Some worry that an Evergrande collapse could be the Chinese equivalent to the collapse of Lehman Brothers, an event that could set off a cascade of debt failures and a property collapse in China similar to the 2008 financial crisis in the United States. The Chinese government has already stepped in to support some of the Chinese debtors and most hope and expect that the government will take steps to prevent a full-scale collapse.
2. Global Energy Crisis
Energy has risen to one of the biggest worries facing the global economy as the price of oil and natural gas spike and supplies drop. The price of oil has almost doubled year over year from $40.63 a barrel on October 8th, 2020, to $79.35 a barrel on October 8th, 2021. Meanwhile natural gas has more than doubled over the same period. Europe has been particularly hard hit as Russia reduces natural gas deliveries in an overt attempt to force approval of the Nord Stream 2 pipeline.
3. Inflation
Inflation has spiked year over year as the economy recovers from the Virus shutdowns. There is no question that inflation is uncomfortably high with Consumer Price Index spiking to a 13 year high in August of 5.4% and easing to “only” 5.3% in September. However, there is still a question of whether the inflation spike is only ‘transitory’ a temporary spike associated with the economic recovery or whether inflation is ‘persistent’ and likely to remain high for an extended period. Only time will tell, but persistently high inflation is certainly a worry for investors since it erodes real returns and implies that the Federal Reserve will need to act more aggressively to keep inflation in check.
4. Debt Ceiling
The United States is once again hitting the debt ceiling, and Congress cannot agree on raising the limit, setting the stage for another government shutdown. A temporary agreement was reached this week to fund the government through December 3rd but if no permanent agreement is reached by that time, we could be facing another round of government worker furloughs and other government spending cutbacks.
5. The old list: virus, Federal Reserve tapering, higher taxes, labor shortages, and parts shortages.
Meanwhile, the old list of headwinds has grown into worries. The virus still rages, the Federal Reserve is still contemplating tapering their bond purchases, congress continues to make progress on a significant tax hike, labor markets remain tight, and the global supply chain remains stressed. One might question how the stock market could be doing so well in the face of so many challenges. The answer remains once again the hands of the U.S. consumers who still have unprecedented amounts of cash, and still appear more than willing to spend. Strong consumer spending continues to drive corporate profits higher and bodes well for 4th quarter profits. Corporate profits drive stock prices and despite all the worries this engine, for the time being, is still running. We continue to be cautious but also realize that as investors we want to participate in corporate profits going forward.