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October 2021 Market Report
Investment Review
During the one-month period to 30th September, major equity markets, as measured by the aggregate FTSE All – World Index, fell moderately, with one noticeable exception. Japanese equities rose by 5% while other bourses dropped by between 3% and 5%. The UK narrow and broader indices both outperformed the average, partly due to the sector mix . The VIX index rose sharply to a level of 23.25, now virtually flat over the year to date, reflecting increasing caution. Government Fixed Interest stocks exhibited sharp upward yield moves (see below), the US 10 year for instance, closing the month at a yield of 1.52%, while the UK Government All Stocks Index fell to a level of 178.9, now down over 8.0% in capital terms since the year end. Other bonds also fell price terms during the month. Currency moves featured a stronger dollar and weaker pound, while commodities, with the obvious exceptions of oil and natural gas finished the month in negative territory.
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In terms of global economic data, there have been few official GDP growth revisions in the most recent period, after the strong second quarter rebound, in both developed (especially China and USA) and emerging economies, although more “live†data suggest some softening in USA and UK for example (see below). Inflation indicators however, at least in the short term, have moved upwards for any number of well documented reasons, the latest OECD forecasts being 3.7% and 3.9% for 2021 and 2022 respectively. The IMF latest report predicts 6% global growth this year falling to 4.4% in 2022 but highlights the considerable regional variation. COVID-19 developments during the month featured accelerating cases in some areas (Northern autumn, school return) and a growing debate re the global distribution of vaccine. Uneven vaccination rates and levels of lockdown stringency (enforcement and adherence) continue to influence government support measures and Central Bank actions. The tone of the very recent Major Central Bank meetings has been more “wait and see†re relaxing QE and interest rate moves, although a number of other economies e.g Norway,Hungary,Brazil,South Korea, have already started raising policy rates.
Recent US Federal Reserve meetings have moved the emphasis from unrestrained support for growth and financial markets to the long process of winding down stimulus and eventual tightening. At last week’s meeting, Jay Powell said that the Fed could announce a “taper†of its asset purchases in November, with a possible end to the bond buying programme by the middle of 2022, while half of the committee also expected interest rates to rise as soon as next year.
Recently announced inflation indicators showed headline CPI to end August rising at 5.3% over the year, marginally below some expectations. Provisional second quarter GDP growth of 6.5% was lower than some estimates, but still well above trend. Recent consumer sentiment indicators and provisional PMI figures have all shown a pause in activity/expectations. Independent economic forecasts are now expecting over 6%-8% GDP growth for full year 2021 with unemployment ticking down to around 4.5%.
Recent ECB meetings have seen interest rates maintained at -0.5% and a continuance of the pandemic bond buying programme, a subject of growing debate. It is currently expected that more definitive statements re QE and monetary policy will be made at the November/December meetings. Official second quarter GDP figures and very recent European sentiment surveys have pointed to a varying but generally positive, and better than expected trends for the last four months (see graph below), after the widely expected first quarter economic decline, with the area currently expecting to have at least 70% of the population partially vaccinated by Q3 2021. The interim composite PMI for August, just released, reached a level of 59.5, near its highest level since 2012.
The EU commission currently expects 4.8% economic growth this year. July Eurozone inflation stands at 2.2 % (Germany,September 4.1%!) and surveys suggest that many companies are likely to pass more factory gate price increases to consumers as the year progresses. Some analysts expect the inflation rate to peak at over 3% later this year, well above the current ECB forecast. Political developments have been dominated by Germany, where the SPD have overturned the long-standing CDU domination. A period of horse trading now to be expected before final coalition, but some of the more extreme political combinations are ruled out. An SPD,Green, FDP combination currently seems the most likely combination. Renewable energy, infrastructure spending and a relaxation of fiscal “rules†are likely to dominate investor interest, whatever the eventual coalition breakdown.
Asia excluding Japan, led by China (across all sectors
and property), continues to remain in reasonable economic shape although the
recent news flow has been dominated by Covid issues and specific Chinese events,
both corporate and geo-political. On July 20th the ADB released a
pan-Asian 2021 growth forecast of 4.0% (compared with a projection of 4.4%
earlier this year), with significant country variation e.g Vietnam against Thailand,
the latter very dependent on tourism. Recently, South Korea become the first
big Asian economy to raise interest rates since the start of the pandemic as
record household debt and soaring property prices eclipsed fears over struggles
to contain the Delta covid variant.
China is experiencing some weakness after a positive start
to 2021 with July industrial production, factory output, retail sales,
investment spending, property transactions all weaker than expected. Some
“self-imposed†factors e.g., curbing steel making for environmental reasons
have accompanied flooding, virus breakouts, power shortages and related
restrictions and the PMIs for August, released recently, were well below
expectation, particularly in the services sector. At the time of writing, Evergrande,
the major property development company, moves closer to bankruptcy, with
implications for the sector, bond spreads and Government policy. Stock market
investors have also experienced regulatory crackdowns, affecting a variety of
sectors e.g online tutoring, video gaming, property development, luxury goods
and private equity, to name a few.
Equities
Global Equities showed moderate falls over September 2021, the FTSE ALL World Index registering a decline of 3.1% in dollar terms. The Japanese Nikkei Index was the only major bourse ending the month in positive territory. The UK indices, though still down on the month, performed relatively well, largely due to the energy sector. Chinese equities continued to slide, now down significantly since the start of the year, also contributing to the year-to-date decline in the general Emerging Market space. The VIX index rose sharply, ending the month at 23.25, virtually erasing the year to date fall in one month.
UK Sectors
An unusual month for UK sectors with only the one major sector showing gains. Oil and gas shares rose on a mixture of commodity price move, strong balance sheets and earnings and recovery from an oversold ESG theme. By contrast mining shares, sharply down were affected by the negative comment regarding Chinese economic growth, while several more domestic UK sectors suffered from demand and margin pressures. Since the beginning of the year, UK smaller company funds have significantly outperformed equity “income†funds which have, in turn, matched the “average UK fund.â€. Mixed asset funds have shown growth of between 2% and 8%, depending on the equity weight, since the beginning of the year (Source Trustnet 30th September 2021). The FTSE private client indices show similar year to date returns
Fixed Interest
Gilt showed sharp price falls over the month, the UK 10-year yield for instance finishing the month at 0.93%. Other ten-year government bond prices also showed weakness with closing ten-year yields of 1.52%, -0.2% and 0.06% in USA, Germany, and Japan respectively. Year to date, the UK Government All-Stock Index has fallen over 8%. Corporate bonds also fell over September in price terms as did more speculative grades. All the followed core preference shares held steady outperforming core government stocks in capital and income terms over the year to date and are still recommended if seeking fixed interest exposure with annual yields in the 5.3%-6% area or 10.5% for the more speculative idea. During the month the UK’s first green sovereign bond was issued attracting £10 billion of institutional demand and price at 0.87%,a touch below a similar dated conventional gilt.A retail product is planned before the end of the year according to NS&I.
Foreign Exchange
A more volatile month for currencies featuring a stronger US
dollar and weaker pound, that cross rate moving over 2%. The Chinese Renminbi
continues to move in a tight (semi-managed!) band versus the Dollar. Currency
moves have amplified the £ adjusted performances of overseas indices, the
S&P for instance outperforming the Nikkei by over 17% so far this year in
sterling terms.
Commodities
Looking Forward
Notwithstanding the large human toll and uncertainly still posed by Covid-19 (lockdowns, geographical variations, vaccines) there is growing optimism regarding the longer-term course of the global economy, though the trajectories vary considerably by region. Shorter term indicators seem to point to lower GDP growth and higher inflation, than earlier projections, a potentially worrying combination.
Major central banks currently continue to adopt an easy money policy, supplemented by other measures while Governments provide increasing short- and long-term fiscal support. Interestingly, in some smaller economies where inflation/fx are more of issues, some official increase rate increases have already taken effect.
For equities, the two medium term key questions will be whether/if rising interest rates eventually cause equity derating/fund flow switches, government, corporate and household problems, and how the rate of corporate earnings growth develops after the initial snapback. At this time of writing, companies have delivered half year figures more than estimates (admittedly from low bases), but, going forward, withdrawal of certain pandemic supports, uncertain consumer and corporate behaviour and cost pressures are likely to lead to great variations by sector and individual company.
Following the format of last month, I make the following observations.
Observations/Thoughts
- SECTORS-The dramatic change in equity confidence, from early November, largely because of the Biden election victory and vaccine announcements prompted large sector/style changes with new focus on value, cyclicals expected to benefit from sharper economic growth. This trend has moderated over recent months with some reflation trades fading and some technology stocks, with the notable exception of China, experiencing a relative revival. It seems however too early to call a turn in the value/ growth relative performance trade.
The other major asset allocation decision would be to replace part of the conventional “fixed interest†portion with alternative income plays in the infrastructure, renewables, and specialist property areas. Many instruments in this area provide superior capital growth, income, and lower volatility than gilts for example.
• UK Equities remain a relative overweight in my view, based on a number of conventional investment metrics, longer term underperformance since the Brexit vote, style preference (value over growth) and a vaccine/variant mix which currently supports continued economic momentum, although be aware of the headwinds I have highlighted above. Takeover activity is also clearly increasing with, for example, private equity snapping up UK-listed companies at the fastest pace for more than twenty years, WM Morrison, Sainsbury? being the most recent targets. On current prices, the MSCI UK market PE, yield, and price book ratios on estimated 2022 figures stand at approximately 11.9,4.3% and 1.6 times respectively. Source: Morgan Stanley,IBES September 2021.
- Emerging Markets-Very difficult to adopt a “blanket†approach to the region even in “normal timesâ€, but especially difficult now, with so many different COVID, commodity, debt, geo-political and increasingly natural disaster variables. Interestingly the rush into Emerging Market assets, both bonds and equities, at the start of 2021 has moderated as many dramas have unfolded e. g Turkey, India, Ukraine, Chinese regulation. This latter factor has special relevance to those using Emerging Market Benchmark Indices, most of which are currently showing negligible or even negative performance year to date. The IMF recently warned that several emerging nations could disproportionately suffer from a combination of COVID and adverse reaction to “tapering†by developed counties e.g FX/Interest rate pressures. Extra due diligence is required and remember to understand the currency as well as local market dynamics. One interesting point to note is that Asian/Emerging funds with an income focus are currently outperforming the more general indices, largely due to lower Chinese technology weightings.
- However, within the emerging space, I continue to have a relatively favourable longer term view on Asia, where relative COVID success, stable FX,inward investment and export mix are supportive.Vietnam,South Korea and Taiwan continue to be favoured. The active versus passive debate in 2021, will take extra significance where “China versus the rest†and appropriate tech weighting will be important considerations, especially considering the recent Chinese meltdown. More caution is required in many South American markets with poor COVID-19 situations, deteriorating fiscal balances and inefficient governments, many of which are up for change. Parts of Central Europe are currently showing some resilience, especially when linked to German exports, but the Covid-19 situation is currently worsening in some areas. Russia remains an interesting contrarian play both for bonds and equities. While the scope for political interference remains high (e.g recent elections), this is not a new story, and the economy has maintained a relatively strong position. The Index has a large natural resource weighting.
- Not on near term investor (or government!) worry lists but be aware of the huge government DEBT problem building (tax increases sooner or later). Latest figures show aggregate global debt more than GDP at the global level and the mantra of extremely low servicing costs, is just that! Sunak recently estimated that UK’s exposure to a rise of 1 percentage point across all interest rates was approximately an additional £25 billion in debt service costs. Apart from occasional bouts of term haven buying/liability matching, I expect conventional government FIXED INTEREST to weaken in the medium term and would not be surprised to see the US 10 Year yield to trade back towards the 1.5% to2.0% region sometime this year. Major Central Banks have turned more hawkish over recent months.
kenbaksh@btopenworld.com
1st August,2021