Q3 Global Investment Trends
Macroeconomics and Politics
Global growth continued to move higher in the third quarter but at a slower pace as the Delta variant curbed activity. However, vaccination rates continue to accelerate, alleviating concerns for further lockdown restrictions. Energy and commodity prices trended higher as increased demand has been exacerbated by supply issues; China and parts of Europe have faced shortages in coal and natural gas, intensifying the supply-demand imbalance. The prospect of lower growth expectations and tighter monetary policy weighed on equities, with global equities, as measured by the MSCI All Country World Index, down 1% for the quarter. Bond yields rose globally as inflation remained elevated and central banks have become incrementally more hawkish.
The number of coronavirus cases recorded globally rose above 233 million through September, increasing by 51 million over the quarter. Global vaccination efforts continued, led by developed countries. As of September 30th, approximately 55% of the US population were fully vaccinated, and many parts of Europe have seen significant uptake in vaccinations as well.
U.S. economic growth was weaker than expected as weak property investments and inventory drawdowns due to supply chain issues offset strong consumption. The economy grew by 6.7% on an annualized basis over Q2 2021. The Eurozone continued to see economic activity rebound in Q2 2021, recording quarter-on-quarter GDP growth of 2.2%. The accelerating vaccination program helped boost consumer and business confidence. China’s economy recorded an annual growth rate of 7.9% in Q2 2021 after posting a record growth rate of 18.3% in the previous quarter.
Inflation rates around the world continued to trend higher as economies are reopening. In the U.S., headline inflation recorded 5.3% year-over-year in August. Core CPI, excluding food and energy, increased by 4% over the same period. UK annual inflation touched its highest level since 2012 as it rose to 3.2% in the year to August, up from the previous month’s reading of 2%. The sharp rise can be attributed to a rise in food, restaurant, and transport prices. Eurozone inflation increased by 3% in the year to August, the highest in a decade.
The U.S. Senate passed a bipartisan $1.2tn infrastructure bill. However, House Democrats delayed voting on the $1.2tn infrastructure bill to sort out looming issues with the budget and debt ceiling limit. However, the Biden Administration and senior Democratic leaders have discussed lowering the cost of the $3.5tn package as the party has been given a one-month deadline to pass both the bills.
The Democrats’ efforts to increase the borrowing limit and suspend the debt ceiling were blocked by Senate Republicans. Treasury Secretary Janet Yellen issued a warning to Congress that the U.S. risks running out of funds after October 18. However, President Biden signed a temporary funding bill to prevent a government shutdown until December 3, and a short-term measure to raise the debt limit through early December was agreed to in the Senate.
Credit
Credit markets declined from risk-averse sentiment during the quarter. The Bloomberg Barclays Global Credit Index returned -0.7% during the quarter and over the trailing twelve months. The Bloomberg Barclays Global High Yield Index returned -0.4% for the quarter whilst it rose by 9.5% over the trailing twelve months
The spreads on the ICE U.S. Corporate Index rose by 3bps to 89bps and the spreads on the Bloomberg Barclays Long Credit Index rose by 5bps to 123bps over the quarter.
The U.S. High Yield bond spread over U.S. treasury yields rose by 11bps to 315bps, and the spread of USD denominated EM debt over U.S. treasury yields rose by 15bps to 354bps over the quarter.
We continue to believe that credit is expensive, and that returns will be hampered by low outright yields and compressed credit spreads rather than a turn in credit conditions.
Commodities
Commodities had another strong quarter as the S&P GSCI index rose by 5.2%. The energy sector was led higher by an increase in the price of WTI crude oil, which was up 2.1% to US$75/BBL.
Industrial metal prices rose by 1.6% while copper was down by 3.7%. Gold prices also decreased, ending the quarter 1.2% lower.
The U.S. Dollar appreciated against all the major currencies.
Monetary Policy
The U.S. Federal Reserve (Fed) meeting concluded with nine out of eighteen Federal Open Market Committee (FOMC) members expecting an interest rate hike in 2022 compared to seven officials in June. The Fed also signaled that it may announce a reduction to its pandemic-era monthly bond purchases, totaling $120bn, at its November meeting. The central bank also lowered its economic growth forecast for 2021 to 5.9% from the previous forecast of 7% and increased inflation forecasts to 3.7% from 3.0% in 2021 and 2.3% from 2.1% in 2022.
The European Central Bank decided to ‘recalibrate’ the pace of its monthly Pandemic Emergency Purchase Programme(PEPP) over the next quarter, citing a strong rebound in eurozone growth and inflation. The ECB has been purchasing €80bn a month under the temporary program, which is set to end in March 2022, per the initial edict. The PEPP was an additional tool the ECB used in conjunction with its regular bond buying program, which is expected to be maintained after the PEPP expires.
The Bank of Canada (BoC) maintained the current benchmark rate and pace of asset purchases at its September meeting. The BoC’s bond purchasing program was reduced to C$2bn a week at the start of the quarter; this is the third taper the BoC implemented since the pandemic-induced quantitative easing program was initiated in April 2020.
Equities
Global equity markets suffered a sell-off towards the end of the quarter amidst increased expectations of earlier interest rate hikes by major central banks.
The MSCI All Country World Index fell 1.0% over the quarter while the index rose 28.0% over the trailing twelve months. Both the Growth and Value indices declined over the quarter with the MSCI All Country World Growth Index outperforming the MSCI All Country World Value Index (-0.7% vs -1.2%) for the quarter. However, Value index has outperformed Growth index over the trailing twelve months (32.1% vs 24.1%).
International equities were negative for the quarter, with the MSCI EAFE Index down by -0.4% and the MSCI Emerging Markets Index down over 7%.
Within U.S. equities, large caps outperformed small caps and growth outpaced value. The S&P 500 returned 0.6%, with the Financials and Technology sectors both up by 2.7% and 1.3% for the quarter.
We believe the outlook for equities is more opaque due to increasing headwinds from inflation, tightening policy and a weakening recovery.
Commodities had another strong quarter as the S&P GSCI index rose by 5.2%. The energy sector was led higher by an increase in the price of WTI crude oil, which was up 2.1% to US$75/BBL.
Industrial metal prices rose by 1.6% while copper was down by 3.7%. Gold prices also decreased, ending the quarter 1.2% lower.
The U.S. Dollar appreciated against all the major currencies.
Government Bonds and Yields
The U.S. Treasury yields rose across most maturities. The 10-year Treasury yield rose by 8bps to 1.53%, and 30-year Treasury yield rose by 3bps to 2.09% over the quarter. The 5-year yield rose by 11bps and the 2-year Treasury yield increased 3bps. The 20-year TIPS yield rose by 1bp to -0.39% and 20-year breakeven inflation rose by 1bp to 2.41% over the quarter.
Elsewhere, the 10-year German government bund yield rose by 2bps to -0.19% over the quarter, while the French government bond yield rose by 3bps to 0.16% in Q3. The 10-year UK gilt yield rose 24bps to 0.95%, and the 10-year Canadian government bond yield rose by 12 bps over the quarter to 1.51%.
We continue to believe that the risks are skewed toward higher yields rather than lower. This leads us to believe that returns from government bonds will continue to be hamstrung going forward.