Those invested in the broader equity markets should be happy with this year’s results. Despite rising interest rates, new waves of the coronavirus and China’s backlash against capitalism, risk markets have soared in 2021 with the MSCI World Stock index advancing 19.90 per cent through the end of October.

After a modest slump in Q3, equity markets have resumed their upward trend to near all-time highs on the back of strong corporate earnings fuelled by an economic rebound. Leading companies have managed to grow both their top and bottom lines throughout this year’s choppy recovery, seemingly against all odds.

While equity markets have fared well lately, investors need to be watching a few critical markers which could have both short and longer-term impacts on investment portfolios. Indeed, a key to navigating these markets may lie in discerning the difference between short-term noise and longer-term secular trends.

Important markers along the winding road of the pandemic recovery include central bank monetary policies, inflationary pressures, resolution of global supply-chain troubles and the debt ceiling debates in Washington.

In terms of US monetary policy, most economists expect longer-term interest rates to resume their gradual upward trajectory throughout the balance of this year and into 2022.

So far Federal Reserve chairman Jerome Powell continues to confirm the central bank’s resolve to begin tapering, or winding down the systematic purchasing of government notes and mortgage-backed securities in the open market, starting before year-end.

After a strong first half of 2021, macroeconomic data has recently been more mixed but that has not yet altered the Fed’s strategy.

For example, recent US consumer sentiment recently hit a ten-year low, when the index fell to 66.8 while Q2 gross domestic product growth has declined to a post-recovery nadir of just 2 per cent; and yet, that did not seem to alter the Fed’s narrative.

Economists still expect the Fed to begin tapering bond purchases this month with the intention of winding down the current quantitative easing (QE) programme by next summer. Actual interest-rate rises, however, will take longer.

According to the September Federal Open Market Committee (FOMC) minutes, Fed policymakers believe that the Delta wave of Covid-19 cases around the world “were exacerbating or prolonging” the supply-chain bottlenecks that have forced many auto plants to shut down and pushed up prices for consumer electronics, home furnishings, clothing and imported goods. Thus, inflation has become a larger concern in the near term.

Successful resolution of today’s big supply-chain problems therefore represents another key market marker.

These disruptions have led to both higher prices and significantly longer delivery times for many products and these problems could persist longer than expected.

A recent survey by ISI/Evercore’s determined that most managements have pushed out their expectations for when the current supply strains will be alleviated, from early-to-mid 2022 to the second half of next year.

The current situation is separating leaders from the losers. Some well-managed corporations have demonstrated remarkable adeptness in managing through the disruption and those with loyal customers and value-added products have been able to pass on higher costs to consumers. Weaker players are stuck absorbing costs and, in some cases, have seen lower volumes.

Paper products company Kimberly Clark, for example, reported a disappointing quarter last month slammed by supply-chain issues. CEO Mike Hsu stated: “Our earnings were negatively impacted by significant inflation and supply-chain disruptions that increased our costs beyond what we anticipated.”

Kimberly Clark stock fell 2.23 per cent last month, underperforming the MSCI World Stock Index by about 7 per cent.

On the other hand, Raytheon CFO Neil Mitchill called out big gains in commercial aerospace aftermarket businesses of Collins Aerospace and Pratt & Whitney.

According to a Bloomberg report: “Raytheon’s dealing with supply-chain turmoil like everyone else, namely in the form of longer lead times for components and some labour shortages.

But the company has deployed countermeasures such as sourcing from multiple suppliers where possible and expanding “buffer stock” purchases to deal with delayed shipments from suppliers.

While supply-chain issues linger, investors also hope for a budget resolution in Washington. However, longer-term market followers may recognise the US’s apparent political dysfunction as simply part of the typical sausage-making process required to grind out large pieces of legislation.

As I write this, US Treasury Secretary Janet Yellen has just extended the deadline for a potential US government default from December 3 to December 15, allowing Congress more time to increase America’s debt ceiling while political leaders continue to debate the Democrats’ massive social spending and climate Bill.

Expect continuing market volatility and sector rotation in the months ahead as investors continue to weigh the prospects of growing corporate earnings against the headwind of waning monetary stimulus, even as the pandemic recedes and supply chains begin to clear.

In terms of valuations, analysts are expecting a 27 per cent increase in earnings per share over last year.

In recent weeks, earnings expectations have outpaced stock prices, leading to more attractive relative valuations.

The price-earnings ratio on the MSCI World Stock index has declined from a high of more than 25x forward earnings last summer to just around 20x. This lower valuation leaves room for stock market upside if corporate earnings continue to deliver.

Bryan Dooley, CFA, is head of portfolio management at LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult their brokers if such information and/or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.