Key points from the month:
- Range of concerns – Delta variant, elevated inflation, supply chain blockages, spiralling raw material prices, and imminent tapering – are denting sentiment
- US markets saw 2021’s first 5% correction but it remains to be seen whether this decline will persist
- Markets continue to move back towards growth but valuation concerns remain
Persistence of the Delta variant, elevated inflation, supply chain blockages and spiralling raw material prices are merging to form an increasingly dark stain on sentiment. Throw in a new standoff over the US debt ceiling, contagion from the collapse of debt-plagued Chinese property giant Evergrande and imminent tapering from the Federal Reserve, and we could be facing an interesting last quarter of the year.
Bank of America’s latest monthly survey of global fund managers shows what it called ‘tanking macro optimism’, with just 13% of respondents expecting further economic growth, down from 91% in March. Recent weeks have also seen growing fears about a new Cold War between China and the US, with UN Secretary General Antonio Guterres calling on the two to repair their relationship before problems spill into the rest of the world. A flashpoint around the US/UK deal to provide nuclear-powered submarines to Australia has already angered China and France, and Joe Biden attempted to diffuse this bellicose narrative, claiming the Afghanistan withdrawal signals a move from relentless war to relentless diplomacy.
We have long said this year’s equity rally has come without a 5% correction – on average, this happens three times a year – and finally saw that in the third week of September, with coalescing concerns driving pullbacks. While the FTSE 100 has fared relatively better, buoyed by weak sterling and strong oil, the Nasdaq and S&P 500 are struggling to regain momentum. Talk of three-day weeks in the face of gas shortages will likely prove overblown but it remains to be seen whether gathering storms will spark a more sustained equity decline.
Coming back to central banks, the Fed indicated tapering may begin as soon as November at its latest meeting, reiterating comments on a strong jobs market, ongoing economic growth – despite a slight trim to forecasts – and transitory inflation, although chair Jay Powell said this all remains dependant on pandemic containment. Potentially more significant was a sign that interest rate hikes might not be quite as far in the future as markets are hoping: nine of 18 Fed officials now expect to raise rates by the end of 2022, up from seven in June when a majority predicted no hikes until 2023.
An overall dovish tone from the Fed seemed to soothe markets, however, and we appear to have avoided a 2013-like taper tantrum for now, suggesting policymakers have done a good job preparing for future tightening and any impact is priced in. As a warning against moving too soon, however, the Organisation for Economic Co-operation and Development (OECD) has urged central banks to maintain pandemic-related support despite a rebound in global growth. In its September outlook, the OECD advised support for economies should remain while short-term uncertainty persists, including loose monetary policy and guidance on how hot central banks are willing to let inflation run before acting.
Elsewhere, the UK announced the largest month-on-month rise in inflation since records began in 1997, although, as usual, there are extenuating factors. The CPI figure surged to 3.2% in August, after dropping back to 2% in July, but base effects were posited as the reason, with prices 12 months ago significantly lower as part of the government’s Eat Out to Help Out scheme. This should support the argument that higher inflation is temporary but the Bank of England (BoE) also confirmed it expects a 4% peak by the end of the year as elevated prices in commodities look stickier than predicted.
Echoing Transatlantic peers, the Monetary Policy Committee said no immediate action is needed to quell inflation and voted unanimously to hold the main policy rate at historic lows, although recent news on prices has strengthened the case for ‘modest tightening of monetary policy’ over the next few years. The Committee was split 7-2 on the question of whether to end quantitative easing (QE) immediately, with the majority preferring to complete the current programme, which will result in the BoE having purchased £895 billion of government debt by year end. Uncertainty remains around rates, however, with the Bank unwilling to rule out a hike this year and markets pricing in a first rise as early as next February.
In a speech towards the end of the month, BoE governor Andrew Bailey said the UK faces hard yards ahead and rates will ultimately have to rise over the medium term to tame inflation, but the economy is currently too weak to withstand such a move. Referencing that laundry list of problems outlined earlier, he said events over recent months have tempted him to ask when locusts are due to arrive, in a reference to the Biblical plagues of Egypt.
Looking to Europe, initial voting in the German election failed to produce a clear winner, raising concerns of a prolonged decision on the leadership of the Continent’s biggest economy. Olaf Scholz of the Social Democrats has inched ahead of Chancellor Angela Merkel’s conservatives but the latter’s era has ended in near deadlock as parties look to form a coalition.
With sentiment on global growth clearly waning, equity market leadership continues to move back towards quality growth companies and there are questions over whether this year’s value rotation is already petering out. Against such a backdrop, it is worth reiterating our view of the US as the core ‘growth’ market, although, as we covered here, investors need to look beyond these labels when assessing market opportunities.
For much of the past decade, the US has been the standout equity market, due in no small part to the dominance of a small number of tech titans. These businesses are at the cutting edge of a sector that, already in a purple patch pre-pandemic, found itself perfectly placed for stay-at-home spending. On the face of it, valuations in US mega-cap tech remain stretched and require continuation of huge growth or increases in profitability for years to come, as well as standing to benefit from low interest rates. We find it hard to believe there will be no disappointments in future, whether negative surprises in terms of business performance or rate hikes, and concerns on the latter caused a volatile end to September for the tech sector.
This extraordinarily narrow nature of US equity performance is reinforced by figures from S&P Dow Jones Indices, which showed the five current largest stocks in the S&P 500 (Apple, Microsoft, Amazon, Facebook, and Alphabet) have contributed a third of overall returns from the index over five years to the end of August. There has been reams of debate on whether tech superiority can continue but a situation where 1% of companies are producing 33% of performance seems unsustainable. Looking beyond these tech behemoths, however, there are opportunities in the US. Value companies remain attractively priced, and these sectors tend to be more cyclically sensitive so should do well as economies continue to open up.
Key Risks
