Investment Comment August 2021

The main theme dominating markets in July was a continued move away from so-called ‘rotation’ trades, as inflation fears receded and earnings season delivered strong performances for technology stocks. In China, government regulation announcements hit companies in the previously favoured education sector, while fears spread across the Chinese equity market that Beijing (and Washington) may make it more difficult for foreign investors to buy Chinese companies. Actions at the Federal Reserve and European Central Bank also impacted bond markets, underscoring the power held by central banks in those markets.

The MSCI USA benchmark led global equities in July, posting a gain of 1.68%. American technology firms posted impressive quarterly results at the end of July, in some cases far surpassing expectations from analysts. Apple, Microsoft, and Alphabet all saw strong growth, with trends in 5G enabled phones, cloud computing, and online advertising boosting revenues respectively. Despite the stellar revenue and profit gains, the market response was muted, suggesting short-term strong performance has largely been priced in. Meanwhile, US government bonds rallied, pushing yields on long term debt down further as inflation fears were overridden by sentiment that the global recovery is faltering, leading investors to rotate in to ‘safe’ assets like US treasuries, thus driving up the price and decreasing the yield. Further, Jerome Powell, head of the Federal Reserve, indicated the central bank was considering when to taper its vast asset purchase programme, indicating it will remain dovish.

Asia Pacific Equities registered a large decline in July, as the MSCI Asia Pacific ex-Japan fell 5.97%. Chinese equities fell sharply at the end of the month, driven by fears of a regulatory crackdown in technology, education, and healthcare. The sell-off was precipitated by impending regulation of China’s booming education industry, in which tutors are employed to help children pass school and university exams. Beijing has signaled that it will require these companies to become non-profits and will prevent them from raising capital on the market. The share prices of TAL Education Group, Gaotu Techedu and New Oriental Education and Technology fell over 95% from their all-time highs earlier this year. Concerns spread over the use of Variable Interest Entities (VIEs) to circumvent restrictions on foreign ownership of Chinese companies, which have never been formally recognized by the Chinese government, yet have also been tolerated over the past 2 decades. Tencent, Didi and Meituan, three of China’s largest tech companies, were caught in the crosshairs of regulators and shares declined up to 16% in one day.

Commodities drove a strong rebound in mining and oil companies. Rebounds in raw material demand and prices, from iron ore to oil, propelled Rio Tinto, Anglo-American, Royal Dutch Shell and others to one-off special dividends and share buybacks, while countries like Australia benefitted from increased Chinese industrial activity. The West Texas Intermediate crude oil benchmark surpassed $75 in July, up from around $30 a barrel in October 2020. Iron ore prices delivered to Tianjin, another widely watched benchmark, rose above $200 per tonne, again more than double the price of October, just nine months ago.

The MSCI Europe ex-UK equity benchmark posted a moderate gain of 1.46% in July. In Europe, the economic recovery is expected to be slower than that of the US or developed Asian countries, as several states are still grappling with lockdowns and sluggish vaccination rates. However, hospitalisations remain low across the continent, leading to optimism that GDP will return to pre-pandemic levels by 2022. In July, the European Central Bank followed the US Federal Reserve in signalling a tolerance for higher levels of inflation before raising interest rates, while maintaining a policy of asset purchases and negative real interest rates to attempt to boost economic growth in the bloc. Since the start of 2020, the ECB has purchased the vast majority of newly issued eurozone area government bonds. Weaning markets and governments off such a radically supportive programme may prove to be difficult, especially given the high government debt levels of many southern Eurozone countries and the political implications of hawkish policy.

UK equities were flat in July, as the MSCI UK benchmark rose 0.26%. The United Kingdom celebrated ‘Freedom Day’ on the 19^th of July, when many of the more onerous restrictions were lifted. Despite some continued confusion around restrictions, the UK looks set to benefit from increased household spending and positive business sentiment. The United Kingdom also opened up to fully vaccinated Americans and Europeans, dropping requirements for travellers to quarantine on arrival. UK services benefited from a reduction in restrictions and the Euro 2020 championship. The UK Government is hoping to gain first mover advantage by returning to as close to normality as possible.

Japan was spared the worst of the rout in Asian equities, as the MSCI Japan index fell only 1.90%. The Tokyo Olympics began in July, to muted celebration as Japan’s coronavirus restrictions meant no spectators for the opening ceremony or the events. The country is unlikely to receive the traditional boost in consumer spending and tourism from the games. Japanese business sentiment also picked up in manufacturing and output, but services and consumer confidence remained below pre-Covid levels. As with other countries, Japanese factories and exporters benefited from increased demand in China and to a lesser extent the US, while also being able to pass through cost rises and manage demand for products. A comparative weakness in the service sector highlights that economic recovery is not evenly distributed in each country, and furthermore that each country is emerging from the crisis in different ways.

Emerging Market equities declined sharply in July, mainly due to the high weighting to China in the index. The MSCI Emerging Markets index fell 7.33%. However, other emerging markets also struggled: South Africa witnessed its worst period of violence since the fall of apartheid, as factions within the African National Congress vied to assert control over the party and the state. Supporters of Jacob Zuma, jailed in connection with corruption and contempt of court, rioted and wider scale looting took hold. The rand suffered as did many South African and international businesses. Cyril Ramphosa, the incumbent president and architect of the anti-corruption drive, now faces the challenging task of calming both the business community and the partisans of Zuma.

Market sentiment in July was mainly driven by governments and central banks, as policy changes at the ECB, Fed and Chinese regulators, as well as government calls on Covid-19 restrictions from the British and Japanese governments all informed the narratives driving markets this month. Outside of the policymaking sphere it was an excellent earnings month for technology, commodities, and consumer discretionary companies in developed markets. Emerging markets continued to struggle under the weight of the Covid-19 pandemic, which was offset only partially by strong performance in the commodities sector that favours certain Emerging Markets such as Brazil and Russia.

 

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.