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Third Quarter 2021 | Issue No. 35 An Economic & Market Commentary from Trust Point

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Page 1: STAY CONNECTED WITH US!

Third Quarter 2021 | Issue No. 35An Economic & Market Commentary from Trust Point

Page 2: STAY CONNECTED WITH US!

STAY CONNECTED WITH US!

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Third Quarter 2021Market Point

An Economic and Market

Update from Trust Point

Economic growth decelerated during the third quarter, but from very

high levels. Even though COVID-19 vaccinations became more available

(helping further ease restrictions on mobility), uncertainty related to

monetary and fiscal support combined with ongoing labor and supply

shortages led equities to slightly underperform bonds during the past

three months.

As Delta variant cases of

COVID-19 surged in Q3, service

industries such as leisure and hos-

pitality dealt with renewed unwill-

ingness from customers to engage

in close-proximity activities. At

the same time, the manufacturing

sector battled with ongoing labor

and supply shortages, preventing

companies from meeting customer

demand. As a result, output growth

lagged and economic activity fell

short of earlier expectations while

inflation rose at the same time.

On the positive side, the Delta

variant led to greater cooperation

among nations, which accelerat-

ed the pace of vaccinations, an

important development which we

believe will ultimately allow global

economic growth to fully resume.

As bottlenecks go away, backlogs

are cleared, depleted inventories

are rebuilt and consumption

(especially on services) picks up,

economic activity will increase and

extend into 2022 and beyond in a

more gradual way than previously

expected. In our view, this remains

positive for risk assets as it should

help keep central banks relatively

cautious. Importantly, the condi-

tions for weak growth or worse, a

recession, do not currently exist.

Weaker Growth & Higher Inflation in Q3

Dollar Index Level Sept 94.2 92.4 93.9

As of Actual 3 Mos. Ago 1 Year Ago

ISM Manufacturing (>50 = Expansion) Sept 61.1 60.6 55.7

ISM Non-Manufacturing (>50 = Expansion) Sept 61.9 60.1 57.2

Non-Farm Payrolls Sept 194k 962k 716k

Unemployment Rate Sept 4.8% 5.9% 7.8%

CPI Ex-Food & Energy (yoy) Aug 4.0% 3.8% 1.7%

JP Morgan Global Manufacturing Index (>50 = Expansion) Sept 54.1 55.5 52.4

JP Morgan Global Services Index (>50 = Expansion) Sept 53.4 57.4 52.0

US Economic Activity

KEY ECONOMIC DATA

Global Economic Activity

Source: Bloomberg

1910

Corporate Tax Rate

Taft

Wilson Harding

CoolidgeFDR

Truman

Eisenhower

Kennedy

Johnson Nixon

Carter

FordReagan

Clinton

GHW BushGW Bush Pbama

Trump

Biden

Hoover

Proposed Increase

0

10

30

30

40

50

60%

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

26.5%?

Source: Captial Group Strategas

Chart 1: Top Marginal U.S. Corporate Tax Rate Over Time

Page 4: STAY CONNECTED WITH US!

Growth and inflation were not the

only factors affecting markets last

quarter. In Washington, a last-minute

funding bill to prevent a government

shutdown led to some volatility in

markets at quarter-end. Compound-

ing the issue, the ongoing divide be-

tween moderates and progressives

over the $1.2 trillion infrastructure

bill and the $3.5 trillion reconcilia-

tion bill -- designed to expand social

programs with most of the new tax

burden falling on corporations (Chart

1) -- also created some anxiety over

the timing and size of any future fis-

cal stimulus. Finally, at the time of

this writing, Washington was also

still trying to come up with a solution

regarding the debt ceiling, a limit on

how much money the government

can borrow to pay its bills. Since July

21, 2021, the government has used

“extraordinary measures” to keep the

government running, a temporary

solution that many analysts believe

could run its course by the end of

October. History would suggest a

default is unlikely, as failure to raise

or suspend the debt ceiling would

pose a substantial and unacceptable

risk to the U.S. economy. In the end,

Democrats will probably need to ei-

ther tag the debt ceiling onto their

reconciliation bill for the $3.5 trillion

spending plan, package it into a sep-

arate stand-alone reconciliation bill,

or convince enough Republicans to

help craft a solution.

Fourth Quarter 2020

The rally in risk assets over the last

18 months has been abnormally

rapid and large by historical stan-

dards. As a result, equity valuations

and measures of speculative activity

would suggest we are late in the cy-

cle. However, the global economy is

only slowly returning to the 2019 level

of economic growth, which in itself

would characterize more a mid-cycle

scenario (Chart 2). At the same time,

unprecedented and sustained mone-

tary and fiscal support would suggest

we are still early in the cycle. This di-

vergence in the economic policy and

asset markets cycle (Chart 3) is un-

common and largely a function of the

growing importance and role of gov-

ernments and central banks in the

economy and markets. These macro

factors have important implications

for the investment outlook and port-

folio positioning of our clients’ assets.

For now, we recommend maintaining

a pro-growth bias in portfolios, favor-

ing stocks over bonds, value and cy-

clical stocks over defensive or growth

stocks, small caps over large caps

and international stocks over do-

mestic ones. Within fixed income, we

remain cautious about rising inter-

est rates while maintaining inflation

hedges in portfolios.

Is Everything Out of Sync?

Washington in the News Again

Market Point Third Quarter 2021

Chart 2: Global Economy Slowly Returning to the Level of

Economic Growth of 2019

Source: Organization for Economic Cooperation and Development

U.K.

Cumulative GDP change 4Q 2019 to 2Q 2021 OECD total

Italy France Germany Euroarea

EuropeanUnion

Japan Canada G-7 U.S.

1%

0

-1

-2

-3

-4

-5

Chart 3: Early, Mid or Late Cycle?

Source: MRB Partners

Trough

TroughPolicy Support(Early Cycle)

Growth & Inflation(mid Cycle)

Equities &Risk Assets(Late Cycle)

Peak

Expa

nsio

n

Recessio

n

Page 5: STAY CONNECTED WITH US!

Over the last year we have written

about how we have positioned the

equity portion of portfolios for an eco-

nomic recovery, for a time post-pan-

demic when economic growth is

sufficiently strong to support funda-

mentals such as earnings growth.

This conviction has not changed.

We believe equity markets can still

appreciate from increased vacci-

nations leading to higher economic

confidence as we move ever closer

to a more normal world. But, in Q3

a global rise in Delta variant cases

pushed investors to the relative safe-

ty of U.S. stocks and its outsized allo-

cation to growth stocks, and technol-

ogy stocks in particular (Chart 4). We

have seen this before as investors

flocked to growth stocks during the

initial pandemic wave in early 2020,

only to rotate to value and cyclical

stocks toward the end of 2020 and

early 2021, as positive news about

vaccines’ efficacy surfaced and

global economies slowly reopened.

The latest wave of Delta cases ap-

pears to have peaked, which should

be a catalyst for expensive, interest

rate-sensitive growth stocks to con-

cede to attractive value and cyclical

stocks once again.

Delta Variant Encourages Flight to Safety, Boosting Growth Stocks Once Again

An Equity Market

Update from Trust Point

Market Point

Despite the proliferation of the more contagious COVID-19 Delta variant,

global stocks declined by only 1.05% in the third quarter. In the face of

pandemic headwinds, monetary and fiscal uncertainty, and risks from

China increasing throughout the quarter, corporate earnings trends

remained relatively strong, helping the S&P 500 index rise 0.6% for the

quarter while the MSCI ACWI ex-U.S. index fell 3.0%.

S&P 500 4,308 4,298 3,363 2,914 2,168Dow Jones Industrial Average 33,844 34,503 27,782 26,458 18,308NASDAQ 14,449 14,504 11,168 8,046 5,312

US Large Cap Growth 1.2% 14.3% 27.3% 22.0% 22.8%US Large Cap Value -0.8% 16.1% 35.0% 10.1% 10.9%US Mid Cap Growth -0.8% 9.6% 30.5% 19.1% 19.3%US Mid Cap Value -1.0% 18.2% 42.4% 10.3% 10.6%US Small Cap Growth -5.7% 2.8% 33.3% 11.7% 15.3%US Small Cap Value -3.0% 22.9% 63.9% 8.6% 11.0%

International Large Cap Developed (US Dollar) -0.4% 8.3% 25.7% 7.6% 8.8%International Small/Mid Cap Developed (US Dollar) 0.9% 10.0% 29.0% 9.0% 10.4%

Emerging Market (US Dollar) -8.1% -1.2% 18.2% 8.6% 9.2%

Quarter-End 3 Mos. Ago 1 Year Ago 3 Years Ago 5 Years Ago

3 Month YTD 1 Year (Ann) (Ann)

3 Year 5 Year

US Economic Activity

EQUITY BENCHMARK TABLE

Equity Returns (%)

Source: Bloomberg, Morningstar

Third Quarter 2021

Source: Bloomberg

Chart 4: Growth Stocks Outperform Value in Q3

Jul 15 Jul 30 Aug 16

2021

Aug 31 Sep 15 Sep 30

1.4

1.41

1.42

1.43

1.44

1.45

1.46

1.47Russell 3000 Growth Index / Russel 1000 Value Index 1.427

1.427

Page 6: STAY CONNECTED WITH US!

Market Risks (Always) Present

Market Point

Chinese stocks have been under

considerable pressure in 2021, de-

clining 16.7% (USD) through end

of Q3 after leading the way in 2020.

The threat of increasing government

regulations on corporations (Chart

5) and default concerns from high-

ly-leveraged companies has taken a

toll on stock prices. China is current-

ly promoting a greater emphasis on

social equality, informally coined as

“common prosperity.” To accomplish

its goals, the Chinese government

is increasing regulations on com-

panies in sectors associated with

social inequality, including technol-

ogy and for-profit education among

several others. Spooked markets

have resulted as regulations could

be wide-ranging and not insignificant

for corporate profits going forward.

Additionally, large Chinese property

developer, Evergrande, postponed

a scheduled repayment to foreign

bondholders in September as part

of its struggle with $300 billion of

current liabilities, including $90 bil-

lion owed to creditors. News reports

suggest the Chinese government

has already stepped in to facilitate

a debt-restructuring but questions

linger around possible contagion to

other companies, the global econ-

omy, and asset prices. In portfolios,

we remain cautious on China relative

to the broad market.

China Dominates Market Headlines

A recent survey of investors (Chart

6) listed inflation, a Fed-induced

“taper tantrum,” COVID-19 variants,

asset bubbles, etc., as current con-

cerns. Let’s tackle a couple here.

First, the inflation risk stems from the

reopening of the global economy as

demand has increased faster than

supply, a situation that has been

magnified by considerable labor and

supply-chain constraints. As we’ll dis-

cuss in greater detail later, we have

viewed higher inflation as being a

little more stubborn than what his-

torical economic transitions and the

Fed would suggest. In anticipation

of more persistent inflation we have

proactively positioned equity portfoli-

os with a higher allocation to inflation

hedges. Second, the infamous “taper

tantrum” originates from the Fed’s

2013 announcement that it would

suddenly be reducing massive mon-

etary support. Back then, the bond

market reacted violently with U.S.

Treasury yields spiking higher. How-

ever, while equity markets fluctuated

in the months that followed, stocks

ultimately finished higher over the

following 12 months. In 2021, unlike

in 2013, the Fed has very deliberate-

ly conveyed and projected the timing

and pace of similar actions, which

gives us confidence in a relatively

smooth monetary policy transition

for equity markets.

Third Quarter 2021

Chart 5: China Regulatory Actions Increasing

Source: The Daily Shot, Cornerstone Macro

0Nov 20 Dec 20 Jan 21 Feb 21 Mar 21 Apr 21 May 21 Jun 21 Jul 21 Aug 21 Sept 21

5

10

15

20

25

30

Chart 6: Current Stock Investor Concerns

Source: Bank of America

Inflation

What do you consider the biggest “tailrisk”?

A “taper tantrum”

Asset bubbles

China Policy

Other

Aug-21

0 5 10 15 20 25 30 35

Jul-21

US debt ceiling

COVID-19 delta variant

Number of regulatory actions

Page 7: STAY CONNECTED WITH US!

Inflation has continued to be a topic

of concern for many investors. Wag-

es have accelerated, especially in

industries such as manufacturing,

leisure and hospitality. Supply chain

bottlenecks have caused shortages

in goods at the same time that de-

mand is powering back. Higher wag-

es, supply shortages, and increased

demand are forcing companies to

raise prices rapidly. Inflation’s impact

on the bond market is typically man-

ifested through higher interest rates

and lower bond prices as inflation

erodes the purchasing power of fixed

coupons over time. Bond investors

ultimately demand higher rates in

an inflationary environment. Some

policy-makers at the Fed are starting

to acknowledge that inflation risk is

building. However, the overall mes-

sage is that inflation will gradually

come down to the Fed’s target over

the coming months. We agree that

inflation may come down from elevat-

ed levels we saw this past summer

(Chart 7) but we believe it will remain

well above the Fed’s target for some

time. Inflation is just starting to move

into larger components of the Con-

sumer Price Index bucket, such as

services and housing, and both are

areas in which higher prices tend to

be more persistent (Chart 8).

Inflation Running Hot

A Fixed Income Market

Update from Trust Point

Market Point

In Q3 global bonds faced competing forces, which led to an increase

in volatility. Early in the quarter, the Delta variant slowed the pace of

economic recovery, which put downward pressure on yields. Sentiment

then turned, as above-trend inflation data and the Federal Reserve

hinting at tapering asset purchases put upward pressure on bond yields

later in the quarter. The net effect was relatively flat returns from global

bonds for the period.

3 Month T-Bill 0.0% 0.0% 0.9% 2.2% 0.3%2 Yr US Treasury 0.3% 0.3% 0.1% 2.8% 0.8%10 Yr US Treasury 1.5% 1.5% 0.7% 3.1% 1.6%

US Intermediate Treasuries -0.1% -2.8% -3.5% 5.6% 2.4%US Treasury Inflation Protected Sec. 1.8% 3.5% 5.2% 7.4% 4.3%US Mortgages 0.1% -0.7% -0.4% 3.9% 2.2%US Short-Intermediate T/E Munis -0.1% 0.3% 1.1% 3.8% 2.3% US Investment Grade Corporates 0.0% -1.3% 1.7% 7.4% 4.6%US Senior Bank Loans 1.1% 4.4% 8.4% 4.1% 4.6% US High Yield 0.9% 4.7% 11.5% 6.6% 6.4%

Int’l Bonds Ex-US (Hedged) 0.0% -2.3% -1.4% 4.1% 2.6%Int’l Bonds (Unhedged) -0.9% -4.1% -0.9% 4.2% 2.0%

Emerging Market Debt (US Dollar) -0.5% -4.5% 3.9% 5.6% 3.6%

Quarter-End 3 Mos. Ago 1 Year Ago 3 Years Ago 5 Years Ago

3 Month YTD 1 Year (Ann) (Ann)

3 Year 5 Year

US Yields (%)

FIXED INCOME BENCHMARK TABLE

Global Economic Activity

Source: Bloomberg, Morningstar

Third Quarter 2021

Source: Bloomberg

Chart 7: Inflation Has Exceeded All Expectations This Year

4.0

4.5

3.5

3.0

2.5

2.0

1.5

1.0

0.5

‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11 ‘12 ‘13 ‘14 ‘15 ‘16 ‘17 ‘18 ‘19 ‘20 ‘21

3.6

US Core CPI 4.0% US Core PCE 3.6%

Page 8: STAY CONNECTED WITH US!

Market Point

According to Federal Reserve Chair

Jerome Powell, the “substantial fur-

ther progress” test in the jobs market

has been “all but met.” With inflation

already above the Fed’s target, pass-

ing the employment test has paved

the way for the Fed to begin reducing

monthly asset purchases in No-

vember or possibly December. This

“tapering” would be the first time the

Fed has reduced accommodation

since prior to the pandemic in early

2020 and has brought back mem-

ories of the 2013 “taper tantrum.” It

is known as the “taper tantrum” be-

cause bond yields spiked higher and

equity prices fluctuated when the Fed

surprised markets with tighter policy

in 2013. Today, the Fed has absorbed

most of the new U.S. public debt that

has been issued to help finance

emergency fiscal stimulus (Chart 9),

which has led to a massive increase

in its balance sheet. Given the scale

of today’s bond buying program

($120 billion/month), tapering could

again be a risk for investors if the

private sector is unable to absorb the

resulting excess supply of Treasuries.

What is different from 2013 is that

the tapering risk has been well-tele-

graphed and kept separate from the

decision to hike interest rates. The

Fed has convinced the market of no

rate hikes until 2023 and has offset

the tapering conversation with com-

munication that the policy will contin-

ue to remain very accommodative.

However, as we have seen late in the

third quarter, the risk remains to the

upside for yields over the longer term

and we are positioning with caution

to interest-rate risk as the Fed scales

back its asset purchases.

“Taper Tantrum” 2.0?

The global reduction in liquidity may

put upward pressure on bond yields

for some time and will continue to be

of interest for bond investors moving

forward. With the recent move higher

in interest rates, we have benefited

from allocations to short-term bonds,

which are less sensitive to interest

rates. We continue to have exposure

to inflation hedges in fixed income

portfolios to benefit from broadening

inflation pressure. The reduction in

Delta variant cases should allow the

global economy and corporate health

to continue to improve, favoring

credit over high-quality interest-rate

sensitive bonds. In fact, our exposure

to fixed-income sectors tied to im-

proving corporate health and an im-

proving economy have continued to

provide good diversification benefits

while enhancing portfolio yield. On

the other end, we largely continue to

avoid bonds from developed nations

carrying negative yields.

It’s Trending Globally

Third Quarter 2021

Chart 8: Inflation is Moving Into Larger Components of CPI, Such

as Housing

Source: Macrobond, ING

96

5

CPI - Owners’ equivalent rent (lhs) CPI - Primary Rents (lhs)

Case-Schiller house prices advanced 14 months (rhs)

25

20

15

10

5

0

-5

-10

-15

-20

-25

4

3

2

1

0

-1

02 08 1497 03 09 1598 04 10 1699 05 11 17 2000 06 12 18 2101 07 13 19 22

Chart 9: Tapering Could Weigh On Bond Returns

Source: Department of Treasury; Numera calculations

12

8

4

003 06 09 12 15 18 21

US public debt by ownership (TR USD)

Fed & Gov.

Foreigners

Other Private

Mutual Funds

Banks

Page 9: STAY CONNECTED WITH US!

Market Point

Key Investment Themes

Macroeconomics

Asset Allocation

Fixed Income

Equities

• Structurally, Debt, Demographics, and Deglobalization may influence global growth and inflation for years

• Cyclically, growth will improve materially in ‘21/22 (policy support, vaccine availability and pent-up demand)

• Structurally, greater policy support and healthier consumers & banks (vs the 2010 decade) will lead to better growth

• Biggest wild cards: 1) COVID variants & 2) Inflation & growth impact of labor supply shortages

• Tactically, the risk/reward outlook favors stocks vs bonds

• Low bond yields & pricier equity valuations call for modest returns from financial assets over the next 3-5 yrs

• Global macro factors have important implications for various sub-asset classes / sectors

• Important to maintain a diversified approach and not let emotions dictate investment decisions

• Government bond yields are historically low. They do not offer attractive value for long-term investors

• Expect steeper yield curve as CBs commit to keep ST rates low but growth/inflation drive LT rates higher

• Downward pressure on the U.S. dollar favors some unhedged international fixed income exposure

• Strong growth and continued policy support will allow defaults and spreads to stay low/tight. Favor credit

• Equities continue to benefit from ongoing policy responses and greater mobility as vaccinations efforts ramp up

• Volatility has subsided as investors get more clarity on the outlook going forward

• 1H21 earnings were very strong and have led to ongoing upward revisions of earnings estimates for 2H21 and 2022

• Small-cap, value and Int’l stocks offer good value in a cyclical recovery

Third Quarter 2021

Page 10: STAY CONNECTED WITH US!

Market Point

Tactical Asset Allocation

Fixed Income

- Underweight + Overweight

EquityAsset

Allocation

Growth

Large Cap

Technology

Value

Small Cap

Financials

Equity

Interest-Rate Risk

Government Debt

Developed Sovereign

Corporate Credit

Inflation Protection

Developing Markets

Fixed

Income

In the third quarter we maintained our overweight position to equities relative to fixed income. Within equities, we have maintained our

bias to small cap and value stocks which we expect to benefit from the market rotation away from growth and large cap technology re-

lated stocks. We also continue to favor Int’l equities. The equity portion of portfolios has maintained a bias toward cyclical sectors of the

economy which have benefited from broadening economic growth due to the combination of widespread vaccinations, easy monetary

policy and fiscal stimulus. We continue to favor corporate credit within fixed income as credit is directly benefiting from easy monetary

policy and low interest-rates. We also maintained our inflation hedges and positioning for further yield curve steepening. We continue

to position portfolios to ensure that we can provide the best risk-adjusted returns without taking unnecessary risks.

Profile Summary

Tactical Asset Allocation

Individual client portfolio positioning, performance and transactions therein can vary greatly based on factors including investment strategy, objective, limitations, risk tolerance, time horizon, asset allocation and tax implications.

Third Quarter 2021

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You can’t time the markets, but you can get timely updates! Receive the latest investment insights delivered right to your inbox each week.

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Market Point is a quarterly market commentary designed to provide you with an overview of economic conditions, as well as equity and

fixed income market summaries for the quarter.

This commentary is offered by the Investment Management team. The individuals contributing to Market Point are pictured from left to

right: Randy Van Rooyen, CFA®, Yan Arsenault, CFA®, CAIA®, Ryan Bergan, MBA, Steve Brudos, Brandon Hellenbrand, CFA®, Brett

Sebion, Christine Doll and Nolan Gaffney. Please feel free to contact any team member with questions.

The opinions herein are those of Trust Point Inc, are made as of the date of this material, and are subject to change without notice. Trust Point uses its best efforts to compile its data from reliable sourc-

es, however, it does not warrant the accuracy, completeness or timeliness of any of the information provided. This publication is prepared for general information only. This material does not constitute

investment advice and is not intended as an endorsement of any specific investment. Investors should seek advice regarding the appropriateness of investing in any securities or investment strategies

discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. All investing involves the risk of loss, including principal, a reduction in

earnings, and the loss of future earnings. Past performance is no guarantee of future results. Individual client portfolio positioning, performance and transactions therein can vary greatly based on factors

including investment strategy, objective, limitations, risk tolerance, time horizon, asset composition, asset allocation and tax implications.

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