That Was Short-Lived

Weekly Market Update | September 27, 2021

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Highlights

Globally, stocks were little changed after a volatile week with the MSCI All Country World Index eking out a 0.1% gain. In the U.S., the S&P 500 rose 0.5% while the Dow Jones climbed 0.6%. Emerging markets underperformed as Chinese shares tumbled further. The 10-year U.S. Treasury yield jumped following the Fed’s September meeting - rising from 1.30% to 1.45%.

Concerns of possible financial contagion rose sharply early last week as China’s second-largest property developer appeared to be heading towards a default on its bonds. However, fears eased as the potential failure seemed somewhat contained and U.S. bank exposure seemed limited. Longer-term concerns about a potential slowing in China’s economy remain valid.

The Federal Reserve also moved markets by strongly signaling that a tapering of its monthly bond purchases could be announced as soon as their November 3 meeting. Although investors were concerned that the U.S. stock market might react negatively to such news, risk-sentiment seemed to improve as the uncertainty cleared. Interestingly, Fed Chair Powell stated that he does not need to see a blowout September employment report to feel like enough progress has been on the labor market front…simply a decent report. It seems like an official announcement by year-end is almost assured.

Shawn Snyder Head of Investment Strategy,
Citi Personal Wealth Management

Last Week's Close

S&P 500 4,455 ()

dow jones industrial average 34,978 ()

NASDAQ 15,048 ()

The Week in Review

Housing data improved in August.

Housing starts jumped 3.9% during the month to an annualized pace of 1.615 million units. However, it should be noted that the improvement came on the back of a 20.6% jump in the volatile multi-family starts category. Single-family starts fell 2.8%, which marks the second straight month of declines. Building permits were a bit more uplifting with single-family permits rising 0.6% and multi-family permits rising 15.8%. A rise in permits should translate into a rise in starts over the next couple of months. In general, the housing market remains in good shape with homebuilder sentiment rising for the first time in five months in September.

U.S. Treasury Secretary Janet Yellen called on Congress to raise the debt ceiling.

In a Wall Street Journal opinion piece, she said, ”We are finally emerging from the pandemic crisis. Let’s not plunge ourselves into a financial one.” She followed up by saying, “The U.S. has never defaulted. Not once. Doing so would likely precipitate a historic financial crisis that would compound the damage of the continuing public health emergency….Our current economic recovery would reverse into recession, with billions of dollars of growth and millions of jobs lost.”

That Was Short-Lived

Well, that was short-lived. The Dow Jones fell 614 points last Monday, fell another 51 points on Tuesday and then jumped almost 878 points over the next three days as the relief rally set in (see figure 1). Despite constant calls for a correction at the start of the week, the Dow Jones finished the week up 0.6%. So, what happened?

Figure 1: ... — Figure 1: Daily Point Change in the Dow Jones Industrial Average Last Week

China’s Real Estate Sector Tests Investors’ Confidence

Let’s start with Evergrande. Investors were initially concerned that China’s second-largest property developer would default and lead to a widespread financial contagion akin to the Lehman moment experienced in the United States. However, the U.S. decided to let Lehman fail, which some would argue was a policy mistake. One can rightfully argue about moral hazard and that corporate bailouts should not occur, but letting the institution fail without backstops led to widespread financial contagion and a freezing up of the credit markets that materially worsened the Global Financial Crisis. The key worry with Evergrande, which has about $300 billion in debt, was that it would miss key interest payments on March 22 bond last Thursday. However, in the past week, Evergrande agreed to settle payments on a domestic bond and the Chinese central bank injected cash into the banking system, which helped to soothe fears. The downside of Evergrande is that they may not pay offshore debtholders, which could limit investors’ desire to invest in the country. At this stage it appears that offshore bondholders have yet to receive payment, but the developer technically has 30 days to make those payments before being declared to be in default.

While it’s not clear whether or not the indebted developer will eventually fail, fears of widespread financial contagion to U.S. markets were mitigated some when Fed Chair Powell said that “In terms of implications for us, there’s not a lot of direct U.S. exposure. The big Chinese banks are not tremendously exposed, but you would worry it would affect global financial conditions through global confidence channels and that kind of thing.” In our opinion, the key takeaway is that growth may be set to slow in China as it restructures its economy and copes with a highly leveraged real estate sector. Our advice to U.S. investors is to trim exposure if your portfolio has significant exposure. However, if you have little exposure, now may be an ideal time to add exposure, but investors should acknowledge the ongoing geopolitical risks associated with President Xi’s concentrated drive towards common prosperity.

The Man is for Tapering

The Federal Reserve finally gave the market what it was looking for – clear guidance on tapering the pace of its bond purchases. While investors were nervous that a tapering announcement would upend financial markets, removing the uncertainty seemed to help investor sentiment. Fed Chair Powell said four important things at the September Federal Open Market Committee (FOMC) meeting:

A tapering announcement could occur as soon as next meeting
Tapering would likely be finished by mid-2022
He does not need to see a blowout September jobs report on October 3rd to move on tapering. In his view, he has seen enough progress on the jobs front and a reasonably good or decent report would be enough for a November announcement.
The threshold for rate hikes is much higher than for tapering

If you back into the math required to wind down the current pace of $120 billion in bond purchases by mid-2022, it seems to point towards a November or December start of monthly reductions of $15 billion that would conclude in either June or July of 2022. Clearly, this is not set in stone with Chair Powell saying they could adjust the schedule if the economy started to show weakness, but all signs point to a largely orderly taper. While Powell has been very dovish when it comes to rate hikes, the market is pricing in one rate hike by the end of 2022. Though it could easily be early 2023 and we should also acknowledge that these forecasts rely upon assumptions that may or may not happen. Citi Research’s base case remains that the U.S. economy will expand by 3.8% in 2022 and that inflation will moderate to 2.7%. If that does not happen, then the current projections for the first interest rate hike could easily change…perhaps moving the first rate hike back into 2023.

What Does This Mean for Financial Markets?

The initial reaction has been a renewed rise in the 10-year U.S. Treasury yield, which started the week at 1.36% and closed the week at 1.45%. This jump in yields helped to boost both Energy and Financial stocks, which tend to rise along with interest rates. This is counter to Technology stocks, which tend to fall as interest rates rise as most of their earnings potential is likely to occur further down the road (see figure 2). Essentially, in a raising rate environment, a dollar today is worth more than a dollar tomorrow. Improving economic data may also be contributing to this rise in yields with Citi’s proprietary economic surprise index, which measures whether or not economic data are beating or missing consensus expectations, looking like it may have bottomed in late August. Likewise, early September data like the regional Federal Reserve surveys (such as the Philly Fed index and the Empire state index) are showing signs of a potential pickup in economic activity after an August swoon (see figure 3). This Friday, the national Institute for Supply Management’s manufacturing index should confirm that activity remains solid.

Figure 2: ... — Figure 2. S&P 500 Financials Relative Performance to Technology vs. 10-Year Yield

Figure 3: ... — Figure 3. ISM Manufacturing Index vs. Regional Fed Business Surveys

Longer-term, investors remain rightfully concerned that a normalization in monetary policy could remove a key support of the U.S. stock market. However, if the Fed’s normalization path in 2013 serves as a guide, then these concerns may be overblown. Between the end of 2015 and the middle of 2019, the Fed hiked interest rates nine times, but U.S. stocks went on to post positive annual returns in every single year except 2018 (see figure 4). That was the year when U.S. – China trade tensions led to a manufacturing recession as the Fed continued policy tightening. By mid-2019, the Fed was once again cutting interest rates (see figure 5).

Figure 4: ... — Figure 4: S&P 500 Performance vs. Federal Reserve Balance Sheet

Figure 5: ... — Figure 5: Fed Funds Rate vs. ISM Manufacturing Index

All Eyes Turn to Washington

Looking ahead, all eyes are going to be on Washington with the House set to vote on the $550 infrastructure bill soon. While some expected the first vote to fail, House Speaker Nancy Pelosi said that she will not bring a bill to the floor unless she has enough votes secured for it to pass. Although the vote may be delayed, it is still expected to pass. Importantly, the proposed September 27 vote is non-binding. Our base case remains that the infrastructure bills will get passed with 21 out of 25 (or 85%) of past budget reconciliation bills having went on to be signed by the President. That said, the total price tag of the infrastructure bills will likely be trimmed down from the original $3.5 trillion price tag in order to accommodate moderate Democrats.

Fortunately for financial markets, a trimmed down price tag likely means trimmed down tax increases with the new corporate rate being floated at 26.5% (vs. the initial proposal of 28%), a top individual income tax rate of 39.6% for single filers making above $400,000 (up from the current rate of 37%) and a new capital gains tax rate of 25% (up from 20%, but well below the original proposal of 39.6%). While these examples are just a handful of the changes being considered, we think that a change to the corporate tax rate is likely the most important for financial markets due to its direct impact on corporate profits. While likely to serve as a drag on earnings growth in 2022, Citi Global Wealth still believes that operating earnings-per-share (EPS) growth across the world could rise by 7%-8% on average. This should support further modest gains in global equity markets over the next couple of years.

Should Investors Be Worried About the Debt Ceiling?

In terms of a government shutdown and the debt ceiling debate, it seems like we might see a brief shutdown. Since 1976, we have had 21 government shutdowns with the average shutdown lasting about 8 days…the longest was 34 days (see figure 6). During those shutdowns, the S&P 500 was essentially flat. Recently, Democrats have said that they will include the debt ceiling legislation in with the government-funding bill that is due September 30. While this sets up Congress for a showdown and a potential shutdown of non-essential government services, it should be noted that Democrats have an off-ramp and can always wrap the debt ceiling legislation into the party-line infrastructure bill and pass it with a simple majority.

Figure 6 : S&P 500 Performance During Past Federal Government Shutdowns

Year	President	Dates of Federal Government Shutdown	Number of Days	S&P 500 Performance During the Shutdown (%)
1976	Gerald Ford	September 30 to October 11	10	-3.4
1977	Jimmy Carter	September 30 to October 13	12	-3.2
1977	Jimmy Carter	October 31 to November 9	8	0.7
1977	Jimmy Carter	November 30 to December 9	8	-1.2
1978	Jimmy Carter	September 30 to October 18	18	-2.0
1979	Jimmy Carter	September 30 to October 12	11	-4.4
1981	Ronald Reagan	November 20 to November 23	2	-0.1
1982	Ronald Reagan	September 30 to October 2	1	1.3
1982	Ronald Reagan	December 17 to December 21	3	0.8
1983	Ronald Reagan	November 10 to November 14	3	1.3
1984	Ronald Reagan	September 30 to October 3	2	-2.2
1984	Ronald Reagan	October 3 to October 5	1	0.1
1986	Ronald Reagan	October 16 to October 18	1	-0.3
1987	Ronald Reagan	December 18 to December 20	1	0.2
1990	George H.W.Bush	October 5 to October 9	3	-2.1
1995	Bill Clinton	November 14 to November 19	5	1.3
1995-1996	Bill Clinton	December 16, 1995 to January 6, 1996	21	0.1
2013	Barack Obama	October 1 to October 17	16	2.3
2018	Donald Trump	January 20 to January 23	3	1.0
2018	Donald Trump	February 9	1	1.5
2018-2019	Donald Trump	December 22, 2018 to January 25, 2019	34	10.3
Average			average number of days shut down is 7.8 Days	average percent change for S&P 500 Performance During Past Federal shutdowns is +0.1%

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This table shows S&P 500 Performance During Past Federal Government Shutdowns. Past federal government shutdowns have not materially impacted the stock market.

Sources: Haver Analytics and Citi U.S. Wealth Management as of January 25, 2019. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only. Past performance is no guarantee of future returns. Real results may vary.

In terms of how long they have before the government approaches a default…it looks like they have until either late October or early November. Citi Research is calculating that the hard date is November 3, but there is a high level of uncertainty around the exact date at this point. Rest assured, there is going to be a lot of finger pointing in Washington, but we believe that Congress will once again act to raise the debt ceiling. In fact, Congress has acted 78 times since 1960 to adjust the debt ceiling because neither political party wants to be responsible for defaulting on the country’s legal obligations. Although 2011 stands out as unique period where the debt ceiling debate rattled markets as the country’s debt rating was lowered from AAA to AA+, we do not envision a repeat of that dynamic this time around. Importantly, in 2011, President Obama faced a Republican House, but that is not the case now with both the Presidency and U.S. Congress fully in the hands of Democrats. While thin margins in the Senate suggest heated debates, it seems likely that the debt ceiling debate will come and go without a material impact on financial markets (see figure 7).

Figure 7: Historic Debt Ceiling Levels and S&P 500 Performance

Historical Debt Ceiling Levels and S&P 500 Performance
Date	Debt Ceiling in the billions of dollars	Change in Debt Ceiling in the billions of dollars	S&P 500 Performance (1-Month Prior)	S&P 500 Performance (1-Week Prior)	S&P 500 Performance (1-Month Later)
April 6, 1993	4,370	225	-1.1	-2.4	0.5
August 10, 1993	4,900	530	0.3	0.0	2.7
March 29, 1996	5,500	600	0.8	-0.8	1.3
August 5, 1997	5,950	450	3.9	1.1	-2.4
June 28, 2002	6,400	450	-7.9	0.1	-13.8
May 27, 2003	7,384	984	5.9	3.5	2.6
November 19,2004	8,184	800	6.1	-1.2	2.0
March 20, 2006	8,965	781	1.4	1.6	0.5
September 29, 2007	9,815	850	4.3	0.1	0.9
July 30, 2008	10,615	800	0.3	0.2	-0.1
October 3, 2008	11,315	700	-13.8	-9.4	-12.1
February 17,2009	12,104	789	-7.2	-4.6	-1.4
December 28,2009	12,394	290	3.3	1.2	-3.8
February 12,2010	14,294	1900	-5.3	0.9	6.9
August 2, 2011	16,394	2100	-6.4	-5.8	-6.4
February 4, 2013	16,699	305	2.0	-0.3	2.0
October 17, 2013	N/A	Suspended	1.7	2.4	3.8
February 15,2014	17,212	213	-0.5	2.3	0.1
March 16, 2015	18,113	901	-0.8	0.1	1.1
March 16, 2017	19,809	1696	1.5	0.7	-2.2
September 8,2017	20456	647	-0.5	-0.6	3.6
February 9, 2018	21,988	1532	-4.8	-5.2	6.4
August 2, 2019	N/A	Suspended	-1.4	-3.1	-0.2
July 31, 2021	28,500	6470	2.3	-0.4	3.0
Maximum:			maximum percent change for S&P 500 performance one month prior across all given records in this table is 6.1%	maximum percent change for S&P 500 performance one week prior across all given records in this table is 3.5%	maximum percent change for S&P 500 performance one month prior across all given records in this table is 6.9%
Minimum:			minimum percent change for S&P 500 performance one month prior across all given records in this table is -13.8%	minimum percent change for S&P 500 performance one week prior across all given records in this table is -9.4%	minimum percent change for S&P 500 performance one month prior across all given records in this table is -13.8%
Median:			median percent change for S&P 500 performance one month prior across all given records in this table is 0.3%	median percent change for S&P 500 performance one week prior across all given records in this table is 0.1%	median percent change for S&P 500 performance one month prior across all given records in this table is 0.7%
Average:			average percent change for S&P 500 performance one month prior across all given records in this table is -0.7%	average percent change for S&P 500 performance one week prior across all given records in this table is -0.8%	average percent change for S&P 500 performance one month prior across all given records in this table is -0.2%

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This table shows the historic debt ceiling levels and S&P 500 performance. The debt ceiling debate could lead to increased market volatility, but history suggests that that, on average, market impact has been limited.

Sources: Haver Analytics and Citi U.S. Wealth Management as of July 31, 2021. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Past performance is not indicative of future returns. Real results may vary.

Market Indicators

Figure 8: U.S. Stock Market Returns and Select Assets

Index	Weekly change in percent	year to date change in percent		division yield in percent
Dow Jones	0.6	13.7	29.8	1.8
S&P 500	0.5	18.6	37.2	1.3
NASDAQ	0.0	16.8	41.0	0.6
Instrument	Weekly change in percent	year to date in percent		Level
10-Year Treasury Yield (%)	8.9 bps	53.7 bps	78 bps	1.45%
Gold ($/Oz.)	-0.2	-7.8	-6.3	$1,750.4
Oil ($/bbl)	3.0	52.8	84.6	$74.13

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This table shows returns for various USA equity markets and select assets, in weekly, year-to-date and 12 month changes. Investors have modestly de-risked since the start of September

Figure 9: International Stock Market Returns

Index	Weekly change in percent	year to date in percent		division yield in percent
Global	0.1	13.0	32.9	1.8
Europe	0.2	10.9	30.6	2.7
Japan	-1.1	8.1	24.1	1.9
Emerging Markets	-1.0	-0.3	22.1	2.4

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This table shows the percent changes of stock market returns for Global, European, Japanese and Emerging Markets, over weekly, year-to-date and 12 month periods.

Sources: Bloomberg and Citi U.S. Wealth Management as of September 24, 2021. Note 1 (Equities): Global = MSCI All Country World Index (USD); Europe = MSCI Europe (USD); Japan = MSCI Japan (USD); Emerging Markets = MSCI Emerging Markets (USD). The equity index returns shown here are based in U.S. dollars. Returns for a non-U.S.-based investor can differ significantly depending on the effects of foreign currency exchange. Note 2 (Instrument): Gold = U.S. dollars per Troy ounce; Oil = West Texas Intermediate crude at Cushing, OK. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Past performance is not indicative of future returns. Real results may vary.

The Week Ahead

Figure 10: U.S. The Week Ahead

Date	Time	Event	Period	Surv(M)	Prior
9/27	8:30	Durable Goods Orders	August P	0.7%	-0.1%
9/28	8:30	Advanced Goods Trade Balance	August	-$87.3 billion	-$86.4 billion
9/28	8:30	S&P CoreLogic CS 20-City year on year NSA	July	20%	19.1%
9/28	10:00	Conference Board Consumer Confidence	September	115.0	113.8
10/1	8:30	Personal Income	August	0.2%	1.1%
10/1	8:30	Personal Spending	August	0.7%	0.3%
10/1	8:30	personal consumption expenditures Deflator year on year	August	4.2%	4.2%
10/1	8:30	personal consumption expenditures Core Deflator year on year	August	3.5%	3.6%
10/1	10:00	University of Michigan Sentiment	September F	71.0	71.0
10/1	10:00	Construction Spending Month over Month	August	0.3%	0.3%
10/1	10:00	Institute for Supply Management Manufacturing	September	59.5	59.9
10/1	10:00	Wards Total Vehicle Sales	September	13.20 million	13.06 million

This table lists a number of key economic events, analysis reports and forecasts from influential institutions. The Fed meeting will draw investors’ attention.

Sources: Bloomberg and Citi U.S. Wealth Management as of September 24, 2021

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Highlights

The Week in Review

That Was Short-Lived

Market Indicators

The Week Ahead

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