Monthly performance- October 2021

Sovereign Wealth Partners and InvestSense Pty Ltd

 

Market Commentary

The last week of the month proved to be the most eventful but there was a growing sense throughout that inflation data was sending such a strong signal that even resolute central bankers could not ignore.

Investors had been surprised in recent weeks that the bond market especially had been so sanguine but last week it looks the frog decided to jump. Many will have understandably rolled their eyes when the financial press got excited about 0.1% moves in long-term bond rates, but the 0.6% move in 2-year lending rates in Australia is less equivocally eye-catching.

Equity markets on the other hand, were serenely oblivious to ructions in bond markets as another largely buoyant earnings season sent the Nasdaq and the broader S&P 500 higher throughout the month. This was despite two of the biggest companies, Apple and Amazon, missing earnings and revenue estimates due to supply chain disruptions (and telegraphing more of the same in the lead up to Christmas). Nevertheless, prices held up and 60% of other US companies (a larger than usual proportion) have beat earnings expectations so far.

Europe also enjoyed similarly buoyant stock results (especially from financials and energy companies). That meant the US and continental Europe enjoyed the strongest month since last November when Biden had just been elected and several vaccines announced.

After a strong rebound earlier in the month, the Chinese market fell back on domestic growth concerns. While corporate results in the West have been highly supported by real yields, this probably has just as much to do with the market’s resilience. Note that the jump in nominal yields that we saw last week in Australia brought 5-year rates back more or less in line with expected inflation. That means no more free money if this persists. In the US, nominal rates have drifted up, but inflation expectations have been rising faster so real interest rates have been getting ever more accommodative. In that context, the relative performance of the US and tech companies in particular makes more sense.

 

 

Looking Forward

The idea of central bankers no longer being in control could, if it was to become more widespread in the US or Europe, be quite destabilising for markets so we might expect them to retake control of the narrative. Either way central bankers find themselves in a tough spot  if economies start to slow there will be much navel gazing about whether they caused a recession/slowdown. The reality is that markets are always cyclical and are currently at the expensive end of the spectrum, and this time we are in a COVID induced hyper cycle. Maybe the policy mistake has already been made? If the central banks raise rates now, they will be blamed for a recession that was already going to happen. If they wait, they will be blamed for stoking an asset price/debt bubble that they were then forced to burst.

Another scenario that is also gaining traction is that of the ‘muddle through’ where a reflationary tailwind runs into a debt laden headwind and we end up in range-bound markets, perhaps with more volatility and gains that are harder to come by but not necessarily negative. In the ‘muddle through’ scenario the one thing that has changed the most, even more than earnings, is price. If that is the case the returns of the future are unlikely to resemble those of the past even if the performance of economies bears more than a passing resemblance.

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