September Investment Summary
All good things come to an end. The seven-month winning streak for stocks was stopped abruptly in September as the S&P 500 fell just over 4% for the month and the Nasdaq nearly 5%. In Europe, the FTSE 100 fell 0.5% whilst the Eurostoxx 50 was off over 3.5%. Asia fared better as the Nikkei 225 was up nearly 2% and the CSI300 (Shanghai Shenzen) rose just over 1.25%, but both closed well off their intra month highs.
The issues we highlighted last month namely: the Fed (tapering), the delta variant’s impact on activity (supply chain problems), China (Evergrande) and inflation combined to scare investors and some even suggested we were in or entering a period of stagflation. Energy prices and potential energy shortages (a spinoff of Covid related supply chain issues, coupled with weather related problems) also rose to prominence and spooked the markets. All of the aforementioned concerns remain, and these will continue to have economic impacts in the near term. But they are less threatening for the long run and do not suggest an impending recession or the advent of stagflation.
Let us touch on inflation, the Fed and other central bank’s tightening plans. August inflation figures did not provide any real evidence to suggest that the transitory inflation spike was coming to an end. In his recent testimony to the US Congress, Fed Chairman Powell admitted that inflation was staying higher for longer than they had anticipated. US headline CPI posted a 5.3% increase in August and the Fed’s preferred measure of inflation, the core PCE price index, rose 3.6% year-on-year and has now been over 3% for five consecutive months. For the previous ten years, it has never been consistently above 2%. German inflation figures rose to 4.1% for August and for the Eurozone it was 3.4%. Markets are beginning to get nervous that central banks may have to act sooner and more forcefully. Ten-year yields on US treasuries rose nearly 30 basis points at one point during the month. This may have weighed on equities. It was disturbing for balanced portfolios that fixed income provided little if any protection to equity price declines.
Well, is this it? Do risk assets continue lower from here? Is the best of 2021’s returns behind us? Tough questions. We do not think so, but this month and this quarter may prove to be more volatile than the first three quarters of the year were.
Firstly, China is going to continue to be a concern. The Chinese government has embarked (justifiably in our opinion) on a policy of reducing the economy’s reliance on debt and rampant credit growth. Home building has been a large part of Chinese growth over the last decade and it has certainly relied on reckless lending, and the belief that home prices only rise (where have we seen that before?). The challenge for the authorities is to reduce this growth without engineering a rapid house price fall and construction contraction that damages the broader economy. There is no easy way to manage this. The Chinese authorities can and will force the large state-owned banks to rollover existing debt (no matter how dubious) to prevent a full-on credit crisis. They will certainly take measures to stimulate other areas of the economy.
Do not be surprised if the Chinese currency begins to weaken, in an attempt to try and stimulate exports. However, whatever they do, short of giving up on slowing the housing and real estate markets they will not be able to fully offset the slowdown in activity that is occurring.
Secondly, energy price concerns are going to remain with us through the winter. A dangerous cocktail of reduced investment in energy extraction, weather related issues with renewable energy production and other Covid supply chain issues have created a shortage in natural gas that can’t be quickly replaced. Prices will likely go higher for oil and certainly natural gas. This will hurt activity and keep headline inflation high. Let us hope it is a mild winter in the northern hemisphere.
Winter is of course seasonal so the energy problem should naturally go away. China is not seasonal and events there need closely monitoring. If they do not take measures to stimulate other parts of the economy, we would become more cautious regarding the outlook for the country.
As we move into the final quarter of 2021, we believe that central banks will remain very friendly. The Fed reducing their purchases of longer-term securities will be measured and is, for the most part, factored in by the markets. No major central bank will be raising rates, certainly in the short-term. Labour markets remain tight, personal income and balance sheets are strong. Businesses need to rebuild inventories and boost capex. World economic growth will remain above trend, even as it slows from its pandemic re-opening highs. Stagflation is not on the horizon. We still favour equities and view near term weakness in prices this quarter as an opportunity to put cash to work.
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