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Cross-asset relationships were peculiar in September: It was the only month since 1990 in which equities fell more than 2%, bonds declined more than 0.5%, commodities increased more than 2%, and the US dollar rose more than 1%. September presented a wide range of risks for investors, including inflation, rising interest rates, the Delta variant, a potential default of a large Chinese property developer, and continued Washington theatrics regarding stimulus and the debt ceiling. However, while these risks bear monitoring, at this point we do not believe they will derail the current economic expansion and equity bull market.

In addition to providing an overview of markets and the economy, this quarter’s Key Investment Perspective examines the history of breakthrough technologies that resulted from government research and development in the second half of the twentieth century. We explain why we believe that natural curiosity in space exploration and the search for extraterrestrial life today may inspire quality R&D that will could deliver big payoffs in the long run.

Key Takeaways

Equities: US equities were flat overall for the quarter, but there was notable dispersion across size and style. US large caps increased modestly by 0.21% while small caps fell 4.36%. Large cap growth continued to outperform in the quarter with an increase of 1.16% compared with a decline of 0.78% for value. However, value outperformed in September as a result of signs that the growth scare was overdone. In international markets, equities in developed economies fared better than emerging markets.

Fixed Income: Interest rates were range-bound during the quarter, and returns were generally flat. US Treasury five- and ten-year yields were mostly unchanged in the third quarter. Domestic high-yield bonds outperformed, returning 0.89% for the quarter, and high-yield spreads increased modestly. Spreads are historically tight, suggesting lower returns from spread compression going forward. Yield curves remained largely unchanged, which can be viewed as incrementally favorable since flattening curves suggest slower growth.

Tactical Asset Allocation: Key Private Bank’s Dynamic Allocation Research Tool (DART) continues to favor stocks relative to bonds. Investor psychology and macroeconomic factors remain favorable, although corporate valuations are stretched even though profitability is strong. We believe the monetary and fundamental conditions are present for the economic expansion to continue. We moved to neutral positions for international developed markets and emerging markets and recommend diversified allocations to real assets and alternatives largely in lieu of bonds.