September 2021 Monthly Market Commentary: Increased market volatility fueled by higher energy prices and geopolitical tensions
13 October 2021
MARKET CONTEXT: : Increased market volatility fueled by higher energy prices and geopolitical tensions
Global Macro: The US economy only added 194k jobs in September, the lowest in 2021 and below market expectations of 500k. Meanwhile, commodity prices surged, with oil prices up 10% in September and 55% in 2021, and natural gas prices have doubled year to date, as demand for energy rebounded sharply. Inflation may stay longer than expected, which is likely to affect consumer spending. In China, Evergrande’s partial default on its US$90bn debt and the ongoing regulatory tightening on the tech and education sectors have temporarily scared foreign investors away from Chinese assets. We believe those economic headwinds will be conducive to global market volatility in the coming months. Nonetheless, central banks continue to be accommodative, which, combined with strong economic growth, will support global equity markets in the longer term.
The 10-year US yield rose from 1.30% to 1.52% and the 10-year German Bund yield increased from -0.38% to -0.20%, while the 10-year Chinese government bond yield remained unchanged at 2.80%. Based on our econometric model, over the next 12 months, we expect to see the 10-year US Treasury yield within the [1.2%; 2.0%] range, the 10-year German Bund yield within [-0.4%; +0.2%], and the 10-year Chinese government bond yield within [2.8%; 3.2%]. On the equity side, stock markets experienced a sell-off in September, driven by rising bond yields and investor concerns over faster-than-expected central bank tightening, higher inflation, and moderating growth. Energy shortages and the US debt ceiling stalemate in the Senate also undermined market sentiment. On the currency side, we note a pause in the US dollar secular bearish trend. The USD rose in September and in 2021 against most major and emerging market currencies (e.g. EUR, GBP, JPY, and BRL), with the exception of the RMB as the USDRMB has remained below its 6.50 resistance level over the past months. The USD benefited from its safe-haven status as economic headwinds accumulated ahead of Q4.
Equity: Month to date the S&P 500, Euro Stoxx 50, and Hang Seng Index fell 4.6%, 3.5%, and 5.2%, respectively, amid investor concerns about the Delta variant and the global economic recovery. Fixed Income:The 10-year US yield climbed 21bps in September to 1.52%, fueled by market anticipations of the Fed’s future tapering move; as a result, Emerging Market government bonds (-2.7% in USD; -3.5% in local currencies) and High-yield corporate bonds (-0.3% in USD; -1.7% in EUR) all went down. Currencies: The greenback continued to appreciate against most major currencies ahead of the Fed’s tightening measures: EUR -1.9%, AUD -1.6%; CNY +0.2%; safe-haven JPY -1.1%, CHF -1.7%. Commodities: Gold lost 3.3% in September against the backdrop of a stronger US dollar; oil prices jumped 9.3% amid supply fears.
Covid-19: New waves of infections caused by stronger Covid variants could result in new restrictions and lockdown measures around the world, with a strong negative impact on the economic growth outlook, although higher vaccination rates would limit the risk.
China’s regulatory tightening: Following the implementation of stricter regulations in both the tech and education sectors, Chinese regulators may target other industries, which would further impact financial markets.
Rising long-term interest rates: We expect central banks to start reducing cash injections and tapering their bond purchasing programs within the next 12 months, which will result in higher interest rates and downward pressure on equity valuations. Meanwhile, investors are requiring higher yields to compensate for the risk of governments’ ballooning debt.
US tech bubble & high US equity valuations: Tech stocks remain under pressure, given the highest valuations since the dot-com era and high market concentration, while the Biden administration is expected to take a much stronger stance on the tax and anti-trust treatment of tech companies.
US-China tensions: US-China trade frictions remain strong, with increasing tension around Taiwan and the South China Sea. In addition, the US is maintaining pressure on Chinese companies listed on US stock exchanges by implementing stricter rules targeting Chinese firms.
Hedged bond income portfolios: As interest rates will likely trade in a range over the next 12 months, we highlight the importance of receiving positive carry (income from bonds or money markets) in fixed income portfolios with bond capital gains contributing less to fixed income portfolio returns. As the next move for rates is most likely on the upside, reflecting bond buying tapering from central banks, partial hedging of bond portfolios will be key to optimize risk-adjusted returns.
Chinese equities: The Chinese stock market has underperformed Western equities by c.40% this year amid US-China tensions and increased Chinese regulation on tech firms, with Chinese tech stocks plunging c.40% since January. However, we think the downside risk from here is moderate as the Chinese market started to rebound and US hedge funds and asset managers are building long positions again. For instance, Charlie Munger, Warren Buffet’s investment partner, doubled its Alibaba stock holdings. Alibaba has been growing its top line and cash flow is forecast to more than double in the next few years. Alibaba’s stock price is less than what it was when the company was less than a third of its current size.
Oil & Gas: The energy sector is a major beneficiary of the global recovery, while long-term anticipated oil demand remains robust. Moreover, we are seeing increasing interest from investors towards major energy players that are implementing green energy programs to transition from fossil fuels to clean, sustainable energy production, thus making them major decarbonization contributors.
Financials: We believe the financial sector will benefit from higher yields and a steeper yield curve when long-term interest rates eventually rise, but also from stronger growth via a reduction in nonperforming loans and the positive impact from lower loan provisions on earnings revisions. This would be positive for both the banking and the insurance sectors, where valuations continue to look attractive. We think stocks of well-capitalized quality banks in the US, Europe, Hong Kong, and Japan will pay above-market dividend yields following their central bank’s green light.
Chinese Yuan: The RMB reflects the forward growth of the Chinese economy and the increase in global trade and investments in RMB. The yuan is also becoming an important reserve currency for central banks and financial institutions, underpinned by China’s strong economic fundamentals: a large positive commercial balance, growing domestic consumption, and much higher interest rates than in Western economies. Moreover, China became the number one country in the world for Foreign Direct Investments in 2020 according to the UN, with growing inflows from investors buying Chinese stocks, bonds, and hard assets contributing to the strengthening of the renminbi and consolidating its role as a major trade currency.
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