The week in review

What’s happened in markets?

Figures in the respective local currencies as at the end of trading on 1/10/2021.

The week of 27 September saw inflation data surprise on the upside amid pointers from central bankers that interest rate increases are more likely to come through sooner. Although central banks are still reiterating that a large amount of the inflation is temporary, the supply issues since the pandemic, high demand and the increasing supply bottlenecks are pushing up prices across a number of different areas and industries. And although these may get resolved, the key risk is if prices remain high for a prolonged period of time, which could lead to a cycle of higher than expected inflation and wage increases, making it harder for inflation to fall in the future.

In the US, we saw the annual political debate over government spending and an extension of the debt ceiling. But the risk of a US federal shutdown was narrowly avoided as lawmakers agreed on a deal to extend government spending until 3 December. The key issue at the moment is what’s happening with the infrastructure bill, which is still under discussion.

In the Eurozone, the consumer price index picked up more than expected in September with a headline figure of 3.4%, the highest level in 13 years. The rise has been driven by surging energy prices and the global supply issues, resulting in higher prices feeding through from producers on to the consumer. However, speaking at a European Central Bank (ECB) Forum on Wednesday 29 September, the Federal Reserve (Fed) Chair, Jerome Powell, and the president of the European Central Bank, Christine Lagarde, both reiterated their view that the spikes in inflation are temporary.

In the UK, the fuel shortages abated in some areas of the country, but long petrol station queues remained in London and the South East. The army has been enlisted to assist with deliveries in these regions from Monday 4 October.

Economic data out of China showed manufacturing activity in September contracted for the first time since the pandemic. This is unsurprising given China is grappling with electricity outages due to high coal prices, which are forcing power companies to cut production and ration electricity supply. This has impacted activity across the country at a time when the government is clamping down on property developers and fresh regional outbreaks of the Delta variant are prompting local lockdowns.

In terms of corporate news, the debt crisis at Evergrande, the largest property developer in China, continues to cause concerns for markets, as property forms a significant part of the Chinese economy. As we reported in our update on 28 September, although the company has defaulted on foreign currency debt, it has a 30-day grace period until it’s technically in default. Since then, there have been some positive developments as the company reached a deal to sell a stake in one of its holdings in a commercial bank to a state owned asset manager, which raised US$1.5 billion as a step to resolve some of its debt issues. Trading in Evergrande shares on the Hong Kong Stock Exchange was suspended on Monday 4 October, amid speculation of a potential buyout by another major developer.

In terms of markets, September was a pretty weak month with big divergences in sector performance. Both equity and fixed income markets declined as a result of the Evergrande situation, rising inflation concerns, and slightly more rhetoric from central banks with regard to interest rates, which put upward pressure on bond yields.

Within equities, we saw longer duration growth stocks, such as information technology (-4%), coming under pressure due to the continued shortages of semiconductors and falling semiconductor share values, which, in turn, have had a knock-on effect on other industries. As a result, growth (-4%) underperformed value (-1%) stocks.  Energy stocks (+4%) were helped by rising oil prices, which hit US$80 per barrel for the first time since 2018.

Over the course of September, we have seen a rise in yield curves and yields across the board given increased inflation expectations and, as we mentioned earlier, the more hawkish rhetoric from central banks with regard to increases in interest rates and tapering. The rise in yields has left bond prices in negative territory.

In terms of currencies, we have seen a stronger US Dollar and weaker Sterling. The US Dollar has strengthened on the Fed’s comments about beginning to taper its bond purchases and because of expectations for higher interest rates. Sterling has continued to fall in value, as the UK faces major issues over its energy supply.

What’s happened in portfolios?

It remains a favourable environment for risk assets in general, such as equities, but we are seeing signs of growth moderating from its previous high levels. We have a preference for domestic developed markets – specifically pan-Europe – which are benefiting from the reopening of economies post pandemic, and valuations that are not stretched on a relative basis. This sees us favouring smaller and mid-capitalisation companies over the larger international stocks.

The fixed income environment is less favourable, but that’s not to say it doesn’t have a place in portfolios. In a sudden risk-off environment, it is the only asset class that generates a positive return so it has an important role in terms of risk management practices and policies. We have a clear preference for credit over interest rate duration, and so we believe the current sweet spot is short-dated credit, which enables us to pick up the carry and the yield but with less of the interest rate risk. September was a great month for our high yield managers, AXA and Muzinich, which continued to benefit from their short duration bias as yields have risen.

In other areas, real assets and alternatives appear attractive as an alternative to fixed income and provide some inflation protection. Real assets, for example property, infrastructure and, in particular, renewable energy, can benefit from the current environment. We recently added to our infrastructure holdings via Atlas Infrastructure, where valuations are lagging, offering some recovery potential. In the renewables space, Greencoat UK Wind announced the acquisition of Andershaw Wind Farm for £121 million – equating to 4.8% of its June net asset value (NAV). Andershaw, a 36 megawatts wind farm with 11 turbines, is located in South Lanarkshire, Scotland.

Our alternative strategies, for example music royalties, asset backed income and private equity, continue to provide a credible diversifier within portfolios. One holding, Round Hill Music Royalty Fund, released its first set of results, showing its NAV was up 10% since its inception in November 2020. The company continues to acquire high quality catalogues and recently announced the acquisition of 100% of the master royalty income of 532 original recordings from the iconic American R&B group The O’Jays.

What’s happening this week?

05 Oct • UK & EU Markit Services & Composite PMIs | 07 Oct • US Initial Jobless Claims | 08 Oct • US Nonfarm Payrolls