Oct 8, 2021
Simmering investor anxiety amid a myriad of undercurrents finally came to a boil in September as the confluence of increasingly aggressive comments and actions by major central banks, a spike in US Treasury yields, persisting supply bottlenecks and an energy crunch spooked inflation and growth concerns.
Notwithstanding a brutal September in financial markets, developed market (DM) equities (MSCI World Index, -0.0%) closed the quarter a shave lower, while their emerging market (EM) peers (MSCI Emerging Markets Index, -8.1%) absorbed most of the heavy blows from the global selloff and a torrent of negative newsflow from China. Across regions, September marked the worst month since March 2020 for the US benchmark S&P 500 Index, which plunged 4.7%, but still managed to book a sixth consecutive quarter (+0.5%) of gains. The spike in bond yields was especially brutal to high-growth tech stocks (which also comprise a heavy weighting on the S&P 500) with the tech-heavy NASDAQ sinking 5.3% for the month and 0.2% for the quarter. Across the Atlantic, European stocks suffered the same fate as the Euro Stoxx 600 closed 2% lower. In Asia, returns were mixed, with Chinese stocks (mainland China’s CSI 300 Index, -5.9%) struggling amid Evergrande and weak data, while Japanese equities (Topix, +4.8%) were buoyed by investors piling into beaten down stocks, easing COVID infections and the pledge of a large-scale recovery package by newly minted Prime Minister Fumio Kishida.
In fixed income, inflation worries and the hawkish pivot by central bankers launched a plunge in prices reminiscent of Q1 2021 (yields rise as prices fall). US Treasuries, which serve as an important indicator for financial markets, saw yields on the 10-year note soar from 1.31% to 1.55% in a matter of days. The Bloomberg Barclays Global Aggregate Bond Index ended the quarter down 0.9%.
All returns are quoted in US dollars.
The Delta variant slowed consumer spending and economic expansion in the summer, while inflationary pressures remained at decade highs. Supply constraints have proved much worse than initially anticipated, which has resulted in inflation forecasts being revised higher and growth expectations being lowered. That said, many economists see risks to the economic outlook to be on the upside going forward, once the COVID strain on activity eases. In line with consensus, the Federal Open Market Committee (FOMC) made no changes to monetary policy at its 22 September meeting. Fed Chair Jerome Powell acknowledged in his post-meeting presser that inflation has run hot for longer than expected but downplayed its longevity on the back of the reopening trade, suggesting it should fade over time. Furthermore, he noted the “substantial further progress” test towards the Fed’s inflation and employment goals was “all but met” and further progress could see the FOMC announce the start of tapering as soon as November. On the rates front, Powell reiterated the hiking cycle would travel on a separate timeline, although, it appears that most FOMC participants (9 out of 18) now see rate hikes becoming necessary by next year.
While initially shrugging off the rapidly spreading Delta variant, recent official indicators are pointing toward slowing momentum in the European economy. As in the US, the eurozone’s manufacturing and services purchasing managers’ indicators (PMIs) declined further in September, although the contraction here was a lot sharper as slowing demand growth, supply chain disruptions and rising prices for raw materials continue to weigh on activity. The persistence of rising input costs has further been exacerbated by the disparity in inoculation rates between the developed and developing world, given the interconnected nature of global value chains. That said, the bloc’s economy looks set to deliver robust growth in Q3 on the back of higher vaccination rates through the summer, though the recovery still lags that of the US and China. The European Central Bank’s (ECB) Governing Council (GC) meeting on 9 September concluded with no change in interest rate policy as widely expected. The main attraction to the meeting, however, was guidance on the Pandemic Purchase Emergency Programme (PEPP); the ECB announced that favourable financing conditions could be maintained at a ‘moderately lower’ pace of purchases than the previous two quarters. ECB President Christine Lagarde, however, refrained from labelling this as ‘tapering’ but instead a ‘recalibration’ – with a broader recalibration likely to be announced at the December meeting as the ECB seeks to embark on a gradual normalisation process.
The UK economy bounced back at a rate of 5.5% quarter on quarter (q/q) in Q2 2021, stronger than the initial estimate of 4.8%. While a strong resurgence from the winter lockdown, the economy has still not returned to its pre-pandemic level. With the economy likely to have already peaked since the final removal of restrictions in August, the prospects of clawing back the shortfall appear to be running out of road as the year draws to a close. Recent indicators also point to slowing momentum amid a weaker environment for business and consumers. The UK is poised to lag other advanced economies such as the US and the eurozone, ending the year with a weaker full-year print for 2021. At the same time, a tight labour market and a spike in gas prices are fuelling inflation alongside supply chain disruptions. Pandemic relief measures such as the furlough scheme also expired on 30 September, which are likely to weigh on household finances, leading to weaker consumer confidence and household spending. Bank of England (BoE) Governor Andrew Bailey thus faces a tough and tricky test of keeping inflation in check without further supressing growth conditions. At the time of writing, money markets are pricing in three interest rate hikes in 2023.
Manufacturing activity in China contracted for the first time in 18 months, with the official PMI (National Bureau of Statistics) sliding below the expansionary 50 level in September (49.6). This came in below economists’ expectations of a similar reading to August (50.1). The world’s second-largest economy has had to contend with headwinds from all directions in recent months, including Delta-induced restrictions, supply-chain bottlenecks, a global chip shortage, shutdowns at regional ports, skyrocketing commodity prices and an unprecedented regulatory crackdown across various sectors. In more recent weeks, a deepening energy crisis has added further stress to already stretched global supply chains, while an endangered real estate sector on account of Evergrande’s (one of China’s most indebted property developers) inability to make debt payments has added financial stability angst to an already fragile economic recovery. The People’s Bank of China (PBoC) injected the biggest tranche of short-term liquidity in nearly eight months into the financial system in efforts to calm investor nerves over Evergrande and stem serious contagion to other markets. The confluence of these dynamics and a third straight month of weak data emanating from China has led to various financial entities subsequently lowering China’s growth forecasts for 2021.
South Africa’s economy has proven more resilient than was initially anticipated at the depths of the COVID pandemic, with a GDP print of 1.2% q/q over 2Q, ahead of consensus expectations of 0.7%. Exports remained relatively robust, boosted by a reopening of trade markets and a strong commodity price boom which has been a boon for SA’s mining sector and agricultural exports. Furthermore, the recent revisions in South Africa’s GDP statistics by StatsSA indicated that the SA economy grew by more than previously thought. In particular, the economy is estimated to have registered 11% more growth in 2020 following the rebasing of the GDP calculation to 2015 as the reference year. Manufacturing PMIs remained robust over 3Q as the economic climate improved following the civil unrest which disrupted supply chains and industrial activity. Attention has now shifted to 3Q growth data, which is likely to come in weaker on the back of the July civil unrest and tougher lockdown restrictions amid the third wave of COVID infections. Headline inflation quickened to 4.9% y/y in August from 4.6% y/y in July, above consensus expectations of 4.8%. Transport inflation was the main driver of the increase driven by flight ticket prices. As widely expected, the South African Reserve Bank Monetary Policy Committee unanimously left the benchmark lending rate unchanged at its 23 September policy setting meeting but sounded a more hawkish tone with members now pencilling rate hikes through 2022 and 2023.
The Bloomberg Commodities Index extended its run of positive gains to six consecutive quarters as it advanced 6.6% over Q3. The price of Brent Crude touched US$80 a barrel for the first time in three years, showing signs of a tightening market amid a global energy crunch as supply struggles to meet a surge in demand. Iron ore was on the receiving end of a government-ordered two-month reduction in steel production, of which China accounts for half of the world’s annual total. Another big loser during the quarter was palladium, which continued to reel from the global shortage in semiconductor chips used in the production of vehicles. Elsewhere a military coup in Guinea saw aluminium prices soar to 10-year highs on concerns of potential shortages in bauxite, the aluminium-making ingredient which makes up nearly half of China’s imports.
Figure 1: Q3 2021 % change (US$)
Source: Bloomberg as at 30.09.21.
South African equities ended the month and quarter in negative territory, as positive domestic currents were largely offset by exogenous shocks. The benchmark FTSE/ JSE All Share Index (ALSI) came under immense pressure (down 3% in September and 0.8% over Q3), with regulatory headwinds from China making life extremely difficult for the heavy weighted Naspers-Prosus stable. In contrast, capped indices fared much better as the Capped SWIX ended posted gains of 3.2% for the quarter. At a supersector level, financials (+12%) delivered robust performance, while for resources and industrials it was a bruising third quarter, as both closed 4% in the red. In fixed income, the JSE All Bond Index managed to eke out 0.8% as local bonds were buffeted by intensifying inflation worries, negative developments in China, and hawkish guidance from major central banks – bad news for emerging market debt and currencies. The highly volatile listed property (JSE All Property Index) sector managed to pare back some of the riot-induced losses to close out the quarter up 6.5%. Cash, as measured by the STeFI Composite Index, remained broadly stable at 0.3% for the month and 0.95% for the quarter. In currencies, the rand’s vulnerability to external pressure was typified by its precipitous fall against the greenback, euro and pound sterling.
At the sector level, key leaders included healthcare, which was buoyed by Aspen Pharmacare and Netcare and financials (banks); ‘SA Inc.’ (companies that derive most of their revenue from South Africa) performed strongly over the period, with retailers and travel & leisure doing well amid the reopening trade, notwithstanding the civil unrest earlier in the quarter. On a more negative note, basic materials endured a tough period as the pronounced weakness in base and industrial metals prices (i.e., copper, nickel, iron ore) weighed on the general miners, while the move higher in government bond yields made non-interest bearing precious metals (i.e., gold, platinum, palladium miners) much less attractive.
Selection of FTSE/JSE All Share Index stock performance
|Name||Index weight||Q3 2021 % return (ZAR)|
|The Foschini Group||0.6||-14.1|
Source: Bloomberg as at 30.09.21.