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Investment Commentary-Q3 2021

Published 19/10/2021

In Brief Quarter 3 Overview

  • Q3 2021 saw gains for developed market equities, falls in emerging market equities and was neutral for bonds despite some bond market volatility
  • Progress against COVID has led to increased economic activity worldwide. However, this increased activity has run up against supply constraints, resulting in increased inflation globally
  • Emerging markets suffered during the quarter on the back of further aggressive regulatory action in China as well as a stronger dollar

    July saw a big divergence between western developed markets, and developed Asian and emerging markets. Despite some nervousness around delta variant flare-ups, western markets advanced on the back of ongoing successful vaccine rollouts and generally positive economic data. Japan, China and emerging markets in general suffered, however, as lower total vaccination rates fuelled uncertainty in the face of renewed delta outbreaks. Regulatory crackdowns by China on US listed tech and education companies then exacerbated the emerging market falls.

    August data-releases indicated a slight slowing of growth in countries whose economies reopened earlier, like the US and UK. Likewise, emerging markets and Japan saw a dip in economic activity as they attempted to get to grips with the delta variant, although the strong vaccine rollout programme in Japan began to show some positive effects in helping keep serious cases subdued. Equity markets generally performed well over the month, whilst bond yields started rising on inflation concerns which benefitted shorter-duration bonds relative to longer-duration bonds.

    September was an interesting month for markets, which initially took fright at concerns about the large and systemically important Chinese real estate sector. US and UK monetary policy makers then hinted that rates would rise faster than expected and, in the case of the US Federal Reserve, flagged a future announcement of a slowdown in its bond buying. The result was a marked increase in global bond yields, which also negatively impacted the more growth/quality type stocks (which now make up the majority of equity indices). The equity sell-off was near universal during the month, although Japan was a bright spot as political change and vaccine progress boosted prospects for its economy.

    The third quarter may have ended with a minor selloff in September, but it was positive for developed markets overall. Emerging markets struggled, however, with Chinese tech stocks in particular having a tough time of it. Market volatility, as measured by the VIX index, rose 46.2% over the quarter whilst developed market equities (as measured by the MSCI World Index including dividends) were up 2.4% in sterling terms over the quarter and the FTSE 100 returned 2%. Emerging market equities (MSCI EM Index) fell 5.8%. Global bond yields drifted downwards over the first half of the quarter but then rose over the second, leaving higher quality bonds (as measured by the Bloomberg Global Aggregate Index) essentially flat over Q3. Lower quality ‘high yield’ bonds, less exposed to global yields but more sensitive to the strength of the global economy, were up marginally (+0.1%) over the quarter. Energy commodities again rallied over the quarter with oil up 4.5%. Gold fell 0.7%.

    q3 2021 asset class returns graph
    Data source: Financial Express
    Indices used (including interest & dividends): Defensive Investment Grade Bonds - GBP hedged Bloomberg Global Aggregate Index; Riskier Bonds (High Yield) - GBP hedged Bloomberg Global High Yield Index, Developed World Equities - MSCI World Index in GBP; Emerging Market Equities - MSCI Emerging Markets Index in GBP; FTSE 100 (UK Large Capitalisation Equities)

    Diving into performance within indices, ‘high price’ securities (often described as ‘growth’/’momentum’/’quality’ companies) bounced back strongly after a weaker start to the year, up 3.3% over the quarter. They often perform better in markets more nervous about future growth as they’re seen as being better able to generate that growth without relying on a broader economic recovery. Smaller companies and cheaper ‘value’ companies were more subdued, up 1.0% and 1.6% respectively over the quarter, although they did hold up better than growth equities in September.

    q3 2021 style returns graph 1
    Data source: Financial Express
    Indices used (including interest & dividends): Developed World Equities - MSCI World Index in GBP; Growth Equities – MSCI The World Growth Index; Value Equities – MSCI World Value Index; Small Company Equities – MSCI World Small Cap Index 

    The pound had a weaker quarter, down 2.6% against the US dollar, 2.4% against the yen and 0.2% against the euro.

    Looking Forward

    Towards the end of the third quarter of 2021, global equities saw their first sell-off in about a year as fears emerged that China’s heavily indebted property developer Evergrande Group might lead to the collapse of China’s systemically important real-estate market, as well as major central banks starting to indicate tighter monetary policy than markets expected. More generally, the quarter saw markets begin to worry more seriously about ‘Stagflation’, the worst of all worlds in the form of lower growth (stagnation) and rising prices (inflation). The previous narrative of reflation faltered as growth numbers softened, whilst reported inflation kept on rising.

    Focusing first on inflation, prices have certainly been rising recently, with inflation prints in the US exceeding 5% and UK and Eurozone exceeding 3%.

    inflation line graph 1

    Source: J.P. Morgan Asset Management Guide to the Markets Q4 2021

    The reason for this inflation has been increased demand from economic reopening globally, boosted by easy monetary policy (low interest rates and quantitative easing) and fiscal policy (tax breaks, furlough, unemployment insurance), overwhelming supply chains and production that had been partly damaged by the coronavirus pandemic. This has resulted in shortages (HGV drivers, natural gas, container ships, skilled workers) and higher prices and higher wages which has led to the higher inflation we’re seeing now. Longer term, there are also worries that the costs of transitioning to net zero (replacing capital stock, retraining) may be inflationary too (greenflation).

    Crucially, central banks are starting to indicate that they think this won’t decrease as quickly as they had hoped and so they will need to tighten monetary policy quicker than markets anticipated. Norway hiked its policy rate by 0.25% in its September meeting. Messaging has grown more ‘hawkish’ from the biggest central banks too, with the US Federal Reserve announcing it will soon (probably in November) begin tapering its asset purchase and hinting through its ‘dot-plot’ that rates will increase faster than the market had been pricing in. Whilst we don’t think we’re headed back to the hyper inflation of the 1970s, modestly higher inflation for longer does seem a real risk.


    Source: J.P. Morgan Asset Management Guide to the Markets Q4 2021

    Despite this, we are still cautiously optimistic around our portfolios. Given inflation, it’s tough to make a very attractive case for cash and bonds. There is an acronym that keeps being mentioned with respect to the investment case for equities, though: TINA – “There is no alternative”. Ignoring for now more alternative assets, this boils down to acknowledging that mainstream portfolios have three main asset classes to choose from: cash, bonds and equities. With cash and bonds looking unattractive, equities are seen as the only remaining asset class for protecting and growing wealth going forward, and so should continue to see investor demand and be well supported, provided global growth does not decline too severely.

    And whilst global growth rates have been slowing down, they are still high relative to history. Although markets briefly sold off on Evergrande default fears, they stabilised as investors (rightly in our view) concluded that China had the financial means and incentive to contain the fallout. Evergrande itself is still likely to default but Goldman Sachs revised Chinese GDP forecast for 2021 of 7.8% (from 8.2%), and 5.5% for 2022 (from 5.6%) are still decent levels of growth. It is a similar picture for other economies – growth expectations for the next two years have come down, but they are still higher than the average pre-pandemic.

    investment commentary

    Source: Deloitte COVID-19 Economics Monitor, 1 October 2021

    The same economic unlocking driving growth is also fuelling equity earnings expectations which, despite logistics and cost challenges, remain robust.


    Source: J.P. Morgan Asset Management Guide to the Markets Q4 2021/em>

    And whilst valuations are a challenge for some (but not all) equities in absolute terms, relative to bonds (comparing equity earnings and dividend yields relative to bond yields) even the more expensive parts of the market look reasonable value relative to historical ranges.


    Source: J.P. Morgan Asset Management Guide to the Markets Q4 2021

    However, as is always the case when dealing with the future, caution is warranted. For the majority of clients, holding some bonds and some cash is still useful in case of the unexpected. And investors should do what they can to find other sources of diversification in their portfolios through the judicious use of less mainstream asset classes like high yield bonds, emerging market bonds, listed property and infrastructure and other alternatives. But for most investors, equities can and should form the basis of portfolios going forward, particularly if they can focus on those equity regions and sectors that are more attractive from a valuation perspective, like the UK and emerging markets, and hence even more likely to generate good long-term returns.


    There was little change in developed market central bank action over the quarter as rates were kept low and central bankers maintained quantitative easing, although there was certainly more hawkish messaging around future rate rises and tapering of bond purchases. A number of emerging markets raised rates to control surging inflation in their local markets.

    q3 2021 central banks table 1


    GDP figures released in the third quarter were for Q2 2021, where many developed markets were bouncing back from winter spikes in COVID and so showed solid growth. Inflation increased during the third quarter overall whilst unemployment generally fell as restrictions were lifted and economies continued recovering.

    region table 1


    It was a strong quarter for developed market equities, and in particular Japan which recovered from a disappointing first half of the year. Commodities also saw further gains, fuelled mostly by gains in the energy complex, particularly natural gas. Emerging market equities struggled in sterling terms, however.

    Bonds had a mixed quarter as global yields first fell and then rose. Inflation-linked bonds performed well benefitting from increased inflation fears, whilst emerging market bonds struggled.

    q3 2021 asset classes bar chart 1
    q3 2021 asset classes table 1

    Note: The above returns are total returns, including dividends and interest payments. Asset classes with the “HDG” label are currency hedged to pounds sterling, which means that foreign currency movements are removed whilst those with the “£” label indicate that we are reporting returns to British holders which includes the effects of the foreign currency moves non-UK listed securities are exposed to.

    Data source: Financial Express
    Indices used: 3m GBP LIBOR, GBP hedged version of FTSE World Government Bond Index, GBP hedged version of FTSE WorldBIG Corporate Index, GBP hedged Bloomberg Global High Yield Index, GBP hedged version of FTSE Global Emerging Markets US Dollar Government Bond Index, MSCI North American Index, MSCI Europe ex-UK Index, FTSE All Share Index, MSCI Japan Index, MSCI Pacific ex-Japan Index, MSCI EM Index, FTSE Global Core Infrastructure 50/50 Index,  FTSE EPRA NAREIT Global Index and S&P Goldman Sachs Commodity Index


    investment commentary


    • FTSE 100 is an index of the 100 largest companies by market capitalisation listed on the London Stock Exchange. Crucially, whilst these companies are priced in sterling, the majority of their revenues comes from outside the UK making the FTSE 100 more a global, rather than domestic UK, index.
    • MSCI World Index is used to gauge global developed market equity performance. This is heavily influenced by US equity performance which, as the world’s biggest equity market, makes up more than half of the index. Not to be confused with the MSCI All Country World Index, which includes both developed equities and emerging market equities.
    • MSCI Emerging Market Index measures emerging market equity performance.
    • Bloomberg Global Aggregate Index represents global investment grade bond markets, mostly made up of government bonds.
    • Chicago Board Options Exchange Volatility Index (VIX) is a measure of implied volatility in the S&P 500 Index (how volatile market participants expect big US equities to be/how risky they view them to be). It is also known as the “fear index” – with higher numbers crudely representing “more fear” in markets and lower numbers crudely representing “more greed”.
    • Brent Crude oil prices are a key indicator of movements in the global oil market, the world’s most important commodity as it is such an important input into economic activity (in providing energy and as a raw material in production of materials such as plastics).

    Data Source: PortfolioMetrix, Bloomberg

    *Glossary of Financial Terms

    • Hedging back to sterling: The risk of currency fluctuations can be removed by “hedging” the foreign currency back to the pound. In this way, a UK investor holding a US government bond or bond fund would not experience changes to the pound to US dollar exchange rate and their holding would be a lot less volatile/risky.
    • High yield: High yield debt is rated below investment grade and is riskier. It has a higher yield to compensate for this additional risk.
    • Monetary Policy: The decisions central banks make to influence the supply of money in an economy, primarily the setting of base rates in the economy, but also through certain extraordinary measures such as quantitative easing.
    • Quantitative easing: Quantitative easing refers to expansionary efforts by central banks to help increase the supply of money in the economy (and help indirectly lift the economy). It involves the central bank purchasing financial assets, mainly government bonds.
    • Quantitative tightening: A mechanism for decreasing the supply of money in the economy to cool excess growth (above a stable level). It involves the central bank allowing purchased bonds to mature or in more extreme cases selling previously purchased financial assets.
    • Quarterly vs annualised growth rates: Some national statistical agencies prefer to quote country growth levels in a quarter as an actual quarterly rate (the estimate of growth over three months, x, sometimes referred to as “on quarter” growth) whilst others prefer to quote the growth over the quarter on an annualised basis (i.e. assume the growth over three months continued for a year, 4x). We tried to quote only an annualised rate above using the following approximate relationship: annualised rate = 4 x quarterly rate.

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