Quarterly market themes
The EV Asset Model is empirical in nature and avoids subjective judgements. The relative attractions of different asset classes are driven directly by the model rather than judgement calls.
Being entirely data-driven means it relies wholly on market data to build an objective interpretation of investment opportunities and changes in market conditions over any given period filter transparently through changes in prospects.
In this section, we provide an analysis of the quarter's global financial market themes.
Inflation was certainly the big story in markets. It was inevitable that we would not see the full extent of the damage done to the economy by the pandemic until an attempt was made to restart it. From semiconductor shortages to the fleets of ships anchored off the coast of California waiting to unload their cargo, it’s clear that circulation is still not back to normal.
If the difficulties were confined to the visible problems, they would not mean much. Inflation numbers catch much more and, by the end of the quarter, market talk was of little else. Inflation reached over 5% in the US, even the EU pushed over 3%, and markets are pricing in 7% for the UK. It’s certainly here. The question is how long it’s going to stay.
With such an obvious trigger, it’s reasonable to expect that a lot of the inflation might be a one-off adjustment that the markets and policy makers should "look through". The breadth and variety of adjustments involved make that picture less clear. No rate-setter wants to be the one who did nothing as prices finally took off and recent moves in the markets show the market entertaining the idea that prices have considerable momentum, at least in developed economies.
The cost of short term credit moved up as markets priced in a rate hike which is the usual instrument of choice for combating rising inflation. The quarter started with interest rates trending upward and speculators all set for steepening yield curves but a very slight double whammy of marginally slower economic news and somewhat more hawkish central banks derailed the bond sell-off and rates slumped in August. Since that reset, rates have been trending upward again with enough inflation news to keep it going for now.
Rising rates have been just around the corner since at least the Global Financial Crisis but what people had in mind was a return to some sort of normal. That would mean rates pulled up by economic growth and a surplus of investment opportunities.
What is happening now, in the UK and US at least, is inflation pushing them up. Real, inflation-adjusted, rates haven’t budged and remain at historic lows. What happens next is, more than usually, in the hands of policymakers. Rate setters and finance ministers can get it wrong in both directions with comparable consequences so the situation is likely to remain volatile. The Bank of England and Federal Reserve have both signalled tapering quantitative easing earlier than previously expected while the ECB has thus far resisted calls for curbing its bond-buying programme.
A plethora of headwinds dogged the world’s powerhouse, from geopolitical tensions to various shortages to dollar strengthening. China has had COVID under control and has not really had a bust and boom but has had enough other challenges to make up, and won ground. Relations with Hong Kong and Taiwan are increasingly strained. Regulators and courts have cracked down on the country’s digital economy stars. Uncompromising regulations have burst some bubbles, including bringing the largest property developer to its knees. Energy shortages are hampering its ability to meet the world’s manufacturing demands. Emerging markets in general struggled.
The strong dollar is both a sign of emerging market weakness and, through the cost of financing, a headwind in itself. As a result, Asian and Emerging Markets struggled over the quarter and EM equities, in particular, saw significant repricing.
Resurgent demand, supply squeezes and rising inflation should be great news for commodity investors and a three percent dollar return is not to be sniffed at but it is less than spectacular. Energy and coffee were both strongly up but that serves to highlight the modesty of the gains in other sectors. Gold was actually down in sterling terms over the quarter.