Market Returns – a whistle-stop tour of some of the movers and shakers during the year to date.

The chart shows the returns in local currency across a cross sample of major indices.

The table shows returns broken down by asset class and geography but this time in sterling.  With sterling strengthening against the euro and the yen and only marginally losing ground versus the US dollar, this detracted from returns in overseas markets, in particular those from Japan where yen weakness versus sterling is down 6% in 2021 (so returns for local Japanese investors were even better!).

At face value, the market shape remains broadly the same. US, European & UK equities continue to be strong as the reopening programmes continue to move forward. The noticeable weakness was in emerging and Asian equities, which was led by significant falls in Chinese equities for two reasons. First, the Chinese government announced sweeping regulatory crackdowns in certain sectors, such as education, healthcare and internet infrastructure. Whilst regulatory intervention in China is nothing new, one of the things that is different this time is the extent to which regulations were focused on the economics of a particular sector, barring unbridled profit-making and signalling the end of the era of reckless capital expansion. The broad trend is the government is increasingly recoiling from the capitalist intent that has driven such significant economic growth over recent decades and directing some sectors to work in line with government long term plans and better serve ordinary people, as China tries to develop a society with more wealth and income equality. Second, concerns over the Chinese property sector rose as property developer Evergrande faced looming bankruptcy. Evergrande is no small fish; its total liabilities are estimated to be equivalent to 1.8% of China’s entire GDP or $314bn of which $124bn falls due in the next 12 months. As its order book has 1.7m units awaiting completion, its fate takes on another level of significance. Containment, rather than systemic issue remains the consensus view, but rumblings about the state of China’s property market have the capacity to dampen the outlook for China as housing contributes so much to both China’s household wealth and also wealth inequality.  

The following table shows the winners and losers in terms of industrial sector and style year to date in local currency:

As discussed elsewhere in this Quarterly (see Peaky Blinders section), corporate earnings remain very strong (forecast to be up over 40% for the S&P 500 in 2021 by Factset) and corporate health is improving. This is resulting in overall headline market valuations improving. We remain in a ‘happy place’ for now, but some dampeners to this earnings boom may lie on the horizon with increased corporate tax burdens looking likely and the prospect of rising wage pressures set to chip away at profit margins.

The growth versus value gap continued to narrow marginally but this was not a significant move. Consumer discretionary stocks were noticeably lower as consumer confidence fell back from recent highs as the outlook was weighed down by the spread of the Delta variant particularly in the US, which forms 58% of the MSCI ACWI Consumer Discretionary index. The queues outside petrol stations are highlighting the issues with supplies reaching our pumps, but there are stresses in many areas of the energy complex which are global in nature. The quarter has seen significant price rises in liquefied natural gas (LNG) which has risen almost threefold to $20 mmbtu and thermal coal has doubled in price. The impact on our domestic energy prices will feed through to our pockets in due course. The pricing issues have been compounded by low power generation, as low winds impact production from our offshore wind farms, and a lower than average amount of gas inventory in Europe, as supplies were depleted and not refilled after last year’s cold winter. Unsurprisingly, stocks in the energy sector rallied strongly in the last couple of weeks of September in what was an already strong year for the sector (MSCI ACWI Energy up 34% ytd).

Fixed Income

During the Quarter, index-linked gilts had the strongest returns, but step back and look over the course of the year and this highlights the level of volatility that can be found in some parts of the fixed income world. From a starting point of January 1st, investors could have found themselves down 10% by mid-February. From there to late August the IA index-linked sector average saw a rise of 18% to only fall back to the point where returns for the year are -0.8%. If we stick with sector averages for now and compare the Index Linked Gilt sector to that of the UK All Companies sector over 2021, the volatility stats show index-linked Gilts running at 120% of the volatility of the UK All Companies sector. Food for thought.

At its September meeting, the Federal Reserve prepared markets for the beginning of the process to reduce its asset purchases as well as flagging a more hawkish view on the path of interest rate rises. The famed ‘dot plot’ pointed to six members anticipating at least one US rate rise next year and three in 2023. As we always say the direction of the US Treasury market is crucial for all asset classes. The Treasury market reacted to the Fed through rising yields with the US 10 year finishing the quarter at 1.5%, not wholly different to where it started the quarter, but a reasonable rise from its August lows.

Corporate credit remained more sanguine, but investment grade was more sensitive to these moves in comparison to high yield, which continues to hold on to its positive ground year to date. US and European high yield remained favourable compared to emerging markets or Asia, where there was intense focus on the solvency of property developer Evergrande (see above). 

Credit spreads (the extra yield above government bonds of the same maturity) have tightened considerably since last year and don’t look attractive, but we’re in a ‘least worst’ market and with the default outlook looking benign and yield hungry investors still in plentiful supply, there remain some technical supports for now.

We are nervous of long duration government bonds and have sought shelter in several short-dated fixed income funds or strategic bond funds which have some tools to help mitigate against the negative effect of rising bond yields. 

Currencies

Sterling continues to enjoy its time in the sun versus the euro and in particular the Japanese yen, but has recently been pipped by the US dollar in the year to date charts as the comments coming out of the Federal Reserve boosted the Dollar alongside concerns about fuel and energy prices, raising questions about the strength of the UK recovery.

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