Quarterly Investment Comment October 2021

Sterling denominated returns of major indices	Q3 2021 (%)	H1 2021 (%)	Year 2020 (%)	Year 2019 (%)	Year 2018 (%)	Year 2017 (%)
Equities
UK	1.0	11.2	-11.8	18.4	-9.8	13.0
World (ex UK)	0.9	11.1	14.0	22.0	-3.5	13.3
Emerging Markets	-5.6	6.3	14.7	13.9	-9.3	25.4
Fixed Interest
Overseas Bonds (unhedged)	1.3	-4.5	5.6	2.7	5.1	-2.3
Corporate Bonds	-1.0	-2.5	8.0	9.5	-1.6	4.4
Property	4.0	7.0	-9.5	22.4	-7.8	8.1
Cash	0.0	0.0	0.0	0.0	0.0	0.0

Source: MSCI UK IMI, All Country World Ex-UK, Emerging Markets, UK IMI Liquid Real Estate, Cash Equivalent (GBP 1W LIBOR -1%); BofA ML: Global Broad Market+, Sterling Non-Gilts. Total Return, Sterling adjusted.

 

The quarter ending 30 September 2021 has been eventful with respect to market news but, despite significant weakness in Asia and Emerging Markets, global equities rose marginally (MSCI ACWI 0.86%). China has dominated headlines with a regulatory crackdown in the education and technology sectors; concerns over foreign ownership of Chinese companies; and more recently the liquidity crisis at the Chinese property developer Evergrande. Elsewhere, supply chain disruptions, rising raw material costs and gas shortages point to the possibility that inflation in some of the major developed economies may be less ‘transitory’ than initially indicated by policymakers. As the European Central Bank (‘ECB’), Bank of England and Federal Reserve shift to slightly more hawkish policy following meetings in September, investors are keenly watching the major central banks for confirmation of tapering timelines and the commencement of rate rises.

US equities had a steady quarter, with the MSCI USA index rising 2.04%. The US economy appears to be past its peak rate of growth, with some economic indicators such as employment falling short of analyst expectations over the period. However, September PMIs of 60.5 and 54.4 for Manufacturing and Services, respectively, still indicate an economy in expansionary territory, reinforced by an August inflation reading of 5.3%. The quarter end saw major US indices pull back and 10-year US Treasury yields rise (to 1.56%) on the back of Federal Reserve Chairman Jerome Powell’s caution to legislators that higher inflation rates may last longer than anticipated due to supply chain bottlenecks. Powell had previously indicated that tapering ‘may soon be warranted’, but this latest announcement caused markets to price in the increased likelihood of rate hikes by 2023. Democrats are now under pressure to raise the US debt ceiling to avoid defaulting on government debt obligations. Thus far they have faced stiff opposition to raising the ceiling from the Republicans in the Senate.

Asian and Emerging Market equities were pulled down by news coming out of China over the quarter, with the MSCI Asia ex Japan and the MSCI Emerging Markets indices falling 6.89% and 5.64% respectively. Initially, Variable Interest Entities (VIEs), which enable Chinese companies to list in the US, were in the regulators’ crosshairs in Beijing. Next came an overhaul of China’s private education and technology sectors, which also sparked panic in the medical industry. Companies that teach school curriculum subjects were banned from making profit, raising capital, or listing on global stock exchanges, whilst the Chinese technology giants like Alibaba, Didi and Tencent suffered from anti-monopoly legislation and new gaming restrictions. Finally, the world’s most indebted property developer, Evergrande, is on the brink of defaulting on debt payments, having already missed an $83.5m interest payment in the last week of September. The importance of property to China’s economy has been exposed and the crisis has spread through China’s high-yield debt market. It is currently unclear what support the government will provide and the extent of damage the Evergrande crisis may inflict domestically, or even globally through contagion.

The MSCI Europe ex-UK index fell 0.33% over the quarter.  After Europe’s 7-month streak of positive returns, equities dropped slightly at the quarter-end in response to the monetary tapering announced at the 9 September ECB meeting. The ECB plans to reduce the pace of the Pandemic Emergency Purchasing Programme (PEPP) following improved economic conditions, but Christine Lagarde promises ‘not to overreact to transitory supply shocks’. Inflation forecasts were lifted to 2.2% for 2021 versus a 1.9% estimate back in June, driven by the recovery from the pandemic, higher energy prices and supply chain bottlenecks. Bond yields dropped following the meeting, with the yield on Germany’s 10-year bond (which acts as a benchmark for Eurozone borrowing costs) down four basis points to minus 0.36%. September also saw an historic election in Germany, with Olaf Scholz of the Social Democrats (‘SPD’) winning 25.7% of the vote, ahead of 24.1% for Chancellor Angela Merkel’s CDU/CSU conservative bloc. The SPD is likely to seek an alliance with the Greens and the liberal Free Democrats to secure a majority in parliament and form the country’s first three-party coalition government in history.

The MSCI UK IMI posted a marginal quarterly gain of 0.97%. Whilst UK equities have not soared this summer, UK companies have experienced a wave of interest from private equity firms, attracted by relatively low valuations, cheap financing and favourable regulatory backdrop. UK house prices continue to rise, as do consumer prices, with the inflation rate now expected to top 4% this year. Labour shortages, notably of heavy goods vehicle (HGV) drivers, as well as material shortages and other supply-chain complexities are causing the inflationary pressure. In the final weekend of September, the lack of HGV drivers resulted in delivery complications which sparked a weekend of petrol panic buying across the UK. The explosion in demand resulted in most petrol stations being out of fuel but there are signs the situation is now stabilising. Elsewhere in the energy market, a shortage in global gas supply in September resulted in a spike in gas prices. Unable to pass these costs on to customers due to the UK price cap, nine gas companies serving 1.7m customers were forced to exit the industry. The shortage could add to further inflationary pressure if it leads to gas prices rising into the winter. The Bank of England, however, are maintaining their ‘transitory’ inflation stance and were happy to maintain the base rate at 0.1% in the September Monetary Policy Committee (MPC) meeting.

Japan led the equity markets in the three months to September 30th, with the MSCI Japan posting an impressive gain of 7.61%. However, the fallout from the pandemic is still weighing on consumption, as indicated by the August inflation reading of -0.4% year-on-year, the 11th straight month of falling consumer prices. The buoyant market performance is likely to be a product of the stronger than expected economic growth seen in Q2 this year and an acceleration of the vaccination drive. Japanese equities were then given an unexpected boost in September, when Yoshihide Suga announced he will step down as Japan’s prime minister after just a year in office. Suga’s declining popularity was predominantly attributed to his struggle to contain Covid-19. Fumio Kishida, who ran on the promise of producing a ‘more equitable distribution of wealth’, won the tightly contested leadership battle to become Suga’s successor. Commentators believe it is likely that he will maintain the Abenomics programme of aggressive monetary and fiscal stimulus in the near-term whilst the country is still recovering from the effects of the pandemic.

The principal drivers of market sentiment over the next few months are likely to be the unfolding of the Evergrande debt crisis in China, global supply-chain issues, inflation and central bank rhetoric. Whilst it has undoubtedly been an eventful quarter, media coverage can often seek to hyperbolise events. We encourage clients to try to look past short-term market movements and focus on their long-term goals. We continue to attempt to increase the resilience of portfolios to further volatility and inflationary pressure, focusing on what we can control: asset allocation and fund selection.

Risk warnings
This document has been prepared based on our understanding of current UK law and HM Revenue and Customs practice, both of which may be the subject of change in the future. The opinions expressed herein are those of Cantab Asset Management Ltd and should not be construed as investment advice. Cantab Asset Management Ltd is authorised and regulated by the Financial Conduct Authority. As with all equity-based and bond-based investments, the value and the income therefrom can fall as well as rise and you may not get back all the money that you invested. The value of overseas securities will be influenced by the exchange rate used to convert these to sterling. Investments in stocks and shares should therefore be viewed as a medium to long-term investment. Past performance is not a guide to the future. It is important to note that in selecting ESG investments, a screening out process has taken place which eliminates many investments potentially providing good financial returns. By reducing the universe of possible investments, the investment performance of ESG portfolios might be less than that potentially produced by selecting from the larger unscreened universe.