The week in review

What’s happened in markets?

Figures in the respective local currencies as at the end of trading on 29/10/2021.

In a week that spoke to a key tradition of Hallowe’en, where children are given treats to avoid them playing tricks, the disappointing US Q3 gross domestic product (GDP) data underlined the backdrop affecting the world’s biggest economy. And, although the number came in below expectations at an annualised 2%, lower than the anticipated 2.7% and a dramatic drop from Q2’s 6.7%, it was not a surprise to many given the tricks already served up in the form of inflation, labour shortages, slower consumer spending and supply chain disruptions.

A treat, however, was the expectation that Q4 data will be a lot brighter as Delta variant cases have already come down a lot and the vaccination programme is going well, with approval now extended to Pfizer to inoculate 5 to 11 year olds. The positive forecasts are already apparent in the purchasing managers’ index data (PMI) for the country.

In politics and policy, we saw an upbeat UK chancellor of the exchequer share the independent prediction of the fastest growth for the country since 1973 (up 6.5% versus the earlier projection of 4.0%), which contrasted with the downbeat European Central Bank (ECB).

Although those watching the UK budget could have been forgiven for believing it was not the Conservative party pledging to high fiscal spending, due to the more generous GDP forecasts, others quickly referenced the news that 2022 will see the return to more normal growth, which would come in under the 2% level due to Brexit and pandemic scars.

Meanwhile, the ECB’s Lagarde spoke at its monetary policy session and downplayed any interest rate rises being priced in by markets towards the end of next year. In trying to convince others that rates will increase, she was confident that inflation will be transitory and is set to come down sharply, despite predictions that October’s final inflation announcement on 17 November may see price hikes breach the 4% mark for only the second time ever if they follow the preliminary number for the month of 4.1%.

However, corporate earnings numbers remain broadly positive, with about half of the S&P 500 having released their results and about 80% having beaten analysts’ expectations. With Amazon and Apple publishing disappointing numbers, Microsoft then overtook Apple as the most valuable company in the world as it delivered better numbers, joining the ranks of Alphabet (Google), Caterpillar, General Electric and UPS.

In the equity market in the past 30 days, we have seen broadly positive performance, especially in developed (+0.8%) versus emerging (-2.2%) markets, with many of the former’s indices closing at new all-time highs as the ongoing saga of Evergrande weighed. More generally, growth (+1.4%) and large capitalisation (+0.6%) stocks outperformed their value (-0.6%) and small capitalisation (-0.3%) peers over the past month. The best sector performance was posted by consumer discretionary (+1.8%), while the worst was energy (-1.5%).

What’s happened in portfolios?

The themes playing out in portfolios mirror the previous weeks as we continue to face a more favourable environment for equities versus the fixed income asset class, where we have our biggest underweight. As a result, this sees our positioning summed up as: limited exposure; shorter duration; and focused on credit markets. We believe these fixed income assets are most likely to benefit from the economic recovery.

To reinforce this position, we invested in a new fund in the short duration space run by the managers Lord Abbett, which are one of the oldest money management firms in the US, having been founded in 1929.

The fund is of a higher quality than existing fixed income strategies and is truly a short duration position. While maintaining a short effective duration, it also has a short spread duration, which limits both interest rate and credit sensitivity. This balance between credit and spread duration has proven sufficient to weather headwinds caused by rising rates or widening spreads, and is an important element of the funds returns.

The fund follows a flexible multi-sector, value-focused approach, investing largely in investment grade, as well as mortgage and asset-backed securities. They like these securitised assets because of the attractive valuations and since many of the investments’ default rates have historically been low. And because securitised assets have a complexity premium attached, you tend to get paid a bit more than you might for a comparable credit quality in the corporate space. As such, an AAA Commercial Mortgage-Backed Security offers about the same yield as a single A- corporate bond.

The fund also acts as a good portfolio diversifier and the management team actively rotate sector exposure based on its assessment of relative value, combining top-down macro analysis and bottom-up analysis, which uses a blend of quantitative and fundamental research.

What’s happening this week?

3 Nov • US Federal Reserve Interest Rate Decision | 4 Nov • UK Bank of England Interest Rate Decision | 4 Nov • EU Markit Composite & Services PMIs