The 3rd quarter has now drawn to a close, and investors are sighting a number of cautionary factors to consider for the remainder of the year. After a strong performance in equity markets since the beginning of 2021, investor risk appetite is beginning to show signs of slowing, with the US Fed and many other Central Banks around the world tilting towards tapering their stimulus programs and bond yields around the globe beginning to rise.
In Australia, we saw the extension of lockdown measures in both NSW and Victoria, but that had little negative effect on equity markets, as the market began to price in a delay on the RBA's tapering plans, contrary to many other Central Banks. Improved vaccination rates and a clearer picture of the reopening plans has allowed investors to look through the lockdown related contraction to a solid outlook for the economy in 2022. For the third quarter, the ASX200 posted a +1.7% gain which beat both the US and European indices, which returned +0.6% but lagged Japan which gained a standout +5.3% (all in AUD terms).
In recent weeks, natural gas prices in Asia and Europe have surged, prompting further concerns that inflationary pressures might last longer than Central Banks and market participants currently expect. As the Northern hemisphere heads towards winter, increasing energy costs are expected to impact global growth if the trend continues. The Bloomberg Commodity Index jumped +5% in September and is now up +29.2% year to date. Natural Gas surged +34% in September and +135% for the year. WTI lifted +14.2%. +56% for the year, for the highest monthly close since 2014.
In US corporate news, constant chatter about supply chain constraints dominated the airwaves in September and seemed to be deteriorating rather than showing signs of improving. This news, alongside potential technical factors relating to month-end and quarter-end, triggered a three-day sell-off in US equity markets in the final days of September. The major bourses fell around -5% from the September highs, and US Treasury yields backed up to above 1.50%. WTI crude oil approached levels not seen since 2008 and Brent crude popped above $80/bbl.
September 2021 Summary:
- The S&P500 had its worst month since March 2020 in September as seasonal headwinds came to light.
- Geopolitical and regulatory risks between the US and China have risen sharply in recent months.
- Global energy prices continue to surge alongside commodity markets, with the Bloomberg Commodity Index showing its most significant annual gain in over 40 years.
- IPOs in the US have already reached record levels for the year, with one quarter left to go.
US Equity Markets:
US equity markets saw broad-based weakness in September in what is the seasonally worst-performing month for the S&P500 historically, over both a ten and twenty-year period. September 2021 saw the worst returns of any month since the pandemic began in March 2020, while September 2020 was the second-worst performing month in the same period. The benchmark ended seven consecutive months in the green with a decline of -4.6% on a total-return basis. The Russell 2000 and Microcap indexes fared slightly better with declines of around -2.8%, respectively. Growth and Tech names were hit the hardest, with the Nasdaq losing -5.8%.
Chinese Factors:
Risk appetite soured from the potential systemic risk caused by the Chinese property giant Evergrande and its failure to make several payments to bondholders. At the same time, the Chinese government has been assertive in announcing new regulatory measures and crackdowns on specific sectors, which has raised concerns about further economic damage. There have also been reports of rolling power blackouts at homes and factories, which is impacting their economic data and growth forecasts.
The US Fed:
US Federal Reserve Chair Powell noted that the central bank could begin scaling back its stimulus program as soon as the next meeting in November at the recent FOMC meeting. According to Powell, rate hikes would not likely begin until some time in 2022, after the tapering process is completed. He also changed the language around inflation, refraining from using the term 'transitory' to describe the outlook for inflation, which led some to speculate if the Fed thinks inflation is here to stay. CPI last printed at 5.3% in August, but the Fed believes there should be some relief in the first half of 2022 and that the inflation expectations are still at levels consistent with the 2% inflation target.
Mergers & Acquisitions:
Q3 saw more than $1.5 trillion in global M&A deals, which is +38% on the previous year and set the highest quarter on record. The annual record for M&A deals has already been exceeded in the first nine months of the year, sitting at $4.3 trillion, where the previous annual record was $4.1 trillion set in 2007. So far in 2021, there have been a staggering 770 IPOs, approximately 3x the ten-year average of 205.
Looking ahead:
There is one obvious reason to be cautious about the near-term outlook for equity markets in the months ahead, which is mainly due to rising bond yields. Highly valued growth and tech stocks are most sensitive to changes in interest rates, and the sharp increase in yields in late September highlighted this. Investors must apply more significant discounts to future earnings with higher interest rates, making companies with high forward PE multiples less desirable. As inflation expectations rise, the nominal yields on bonds follow suit, and this is likely to continue in the months ahead.