NOVEMBER 2021 Market Report

During the one-month period to 31st October 2021, major equity markets, as measured by the aggregate FTSE All – World Index, rose moderately, with gains of between 3% and 6%.The UK narrow and broader indices both rose about 2%,now up over12% since the year end .  The VIX index fell sharply to a level of 16.46, now down about 28% over the year to date, reflecting increased risk taking. Government Fixed Interest stocks rose over 1%, mainly following the end October budget while other global 10-year bonds fell in price terms. The UK 10-year gilt ended the month on a yield of 0.97% with corresponding yields of 1.57%, -0.11% and 0.09% in USA, Germany and Japan respectively. Currency moves featured a stronger dollar and firmer pound, while commodities were generally firm, especially in the energy area.

In terms of global economic data, there have been a few official GDP downward growth revisions in the most recent period, after the strong second quarter rebound, in both developed (especially China and USA) and emerging economies, and  more “live” data suggest some softening in nearly all markets. Inflation indicators, at least in the short term, have moved upwards for any number of well documented reasons, and the definition of “transitory” appears very flexible. The latest OECD inflation forecasts are 3.7% and 3.9% for 2021 and 2022 respectively. The IMF latest report predicts 6% global growth this year falling to 4.4% in 2022 but highlights the considerable regional variation. COVID-19 developments during the month featured accelerating cases in some areas (Northern autumn, school return) and a growing debate re the global distribution of vaccine. Uneven vaccination rates and levels of lockdown stringency (enforcement and adherence) continue to influence government support measures and Central Bank actions. The tone of the very recent Major Central Bank meetings has become more hawkish re relaxing QE and interest rate moves, and  a number of other economies e.g. Russia, Norway,Hungary,Brazil,South Korea,Russia,South Africa and New Zealand have already started raising  policy rates.

At recent meetings, Jay Powell said that the Fed could announce a “taper” of its asset purchases in November, with a possible end to the bond buying programme by the middle of 2022. Recent US Federal Reserve meetings have moved the emphasis from unrestrained support for growth and financial markets to the long process of winding down stimulus and eventual tightening. 

 Recently announced inflation indicators showed headline CPI to end September rising at 5.4% over the year, marginally below some expectations. Latest employment figures have shown a weaker than expected bias with great variation between sectors. As well as lower overall job creation, the figures indicate a relatively high cohort leaving the labour market overall. Provisional second quarter GDP growth of 6.5% was lower than some estimates as was the preliminary figure of +2.0% for the third quarter. Recent consumer sentiment indicators and provisional PMI figures have all shown a pause in activity/expectations.   Independent economic forecasts are now expecting over 6%-7% GDP growth for full year 2021 with the unemployment level at around 4.5%. 

 Recent ECB meetings have seen interest rates maintained at -0.5% and a continuance of the pandemic bond buying programme a stance reiterated at the meeting on October 28th. It is currently expected that more definitive statements re QE and monetary policy will be made at the November/December meetings. Official second quarter GDP figures and flash third quarter figures just released (+2.2% ,higher than expected)  and very recent European sentiment surveys have pointed to a varying but generally positive trend, although the very latest PMI’s showed some noticeable deterioration in the manufacturing sector in no small part due to shortages/bottlenecks in the supply chains. The EU commission currently expects 4.8% economic growth this year.

October Eurozone inflation stands at 4.1 %, a 13 year high and surveys suggest that many companies are likely to pass even more factory gate price increases to consumers over coming months. A recent poll by the European Commission showed that European consumer’s inflation expectations were at their highest since 1993.

 Political   developments have been dominated by Germany, where the SPD are edging towards a coalition with the Greens and the FDP.Elsewhere Poland continues a constitutional  standoff with the EU…while corruption issues have led to changes in the Austrian government.

Asia excluding Japan, led by China (across all sectors and property), continues to remain in reasonable economic shape although the recent news flow has been dominated by Covid issues. On July 20th the ADB released a pan-Asian 2021 growth forecast of 4.0% (compared with a projection of 4.4% earlier this year), with significant country variation e.g. Vietnam against Thailand, the latter very dependent on tourism. Recently, South Korea become the first big Asian economy to raise interest rates since the start of the pandemic as record household debt and soaring property prices eclipsed fears over struggles to contain the Delta Covid variant.

China is experiencing some significant economic deterioration after a positive start to 2021 with industrial production, factory output, retail sales, investment spending, property transactions all weaker than expected, and third quarter GDP growth just reported of “just” 4.9%. Some “self-imposed” factors e.g.,  earlier curbing of steel making for environmental reasons have accompanied flooding, virus breakouts, power shortages and related restrictions and the most recent manufacturing PMI dipped below 50.Direct and indirect effects of the Evergrande debacle and a possible new tax are also rippling through the property sector, a significant Chinese GDP component. To kickstart some manufacturing activities, ease power shortages, the authorities have reactivated parts of the coal mining industry, granted some relief to power stations and intervened in the   power pricing mechanism.

The regulatory crackdown which had affected a  variety of sectors e.g. online tutoring, video gaming, property development, luxury goods and private equity, to name a few has quietened “somewhat” but there is a sense that controls could re-appear at any time. 

While there have been no major changes in Japan’s economic trajectory, politics have moved more centre stage with the appointment of a new head of the Liberal Democratic party, Fumio Kishida. The most immediate task of the new leader is to lead the party into a lower house election, that must happen before the end of November. Kishida has signalled that he intends to continue Abenomics for now, but he also has a longer-term goal of a fairer distribution of income. The main economic impact is likely to the continuation/acceleration of a huge stimulus package. The economy grew at an annualised rate of 1.3% in the second quarter higher than some forecasts but still low relative to other G7 countries. At corporate level however, shareholder activism is rising and some of the undoubted value in the market is being unlocked by private equity and other transactions. 

Within the UK, live activity data shows a clear pause in activity following the buoyant second half recovery for several reasons, and certainly a change in the mix of the growth drivers. The composite PMI Index covering August showed an unexpected drop to 55.3, both services and manufacturing, citing staff shortages and other supply constraints as the major reasons, while the more recent “Flash PMI” for September showed a continuation of this downtrend.

 

A skills/age, geographical mis match following the end of the furlough scheme, possible Universal Credit top-up withdrawal, HGV driver shortage, scheduled utility bill increases, public sector strikes, selected VAT hikes, fuel and shop prices and merchandise availability, tax/NI hikes, upward interest/mortgage rate pressure, pension triple-lock suspension and lingering COVID concerns will inevitably lead to more economic uncertainty over coming months. The recent Budget (below) does little to offset these headwinds for many people.

The Budget-The Office for Budget Responsibility forecasts, released on October 27th, show expected growth of 6.5% this year and 6% in 2022, still leaving the economy approximately 2% behind “pre-Covid” levels. The OBR central forecast for CPI is for an increase of 4.4% by spring next year, and not to return to the official 2% target until 2025. The main thrust of Chancellor Sunak’s statement was to spend part   the projected OBR windfall (borrowing less than expected) on public services, but taxation is also set to rise to the highest level since 1950.

The average of leading independent economists now expects UK growth of 5.5% for 2021), lower than earlier year estimates and leaving GDP still short of pre-pandemic levels. 

Forward looking independent economic growth estimates cover a wide range, as the positive argument of relief/catch up spending, by an element of the population from records savings (11.7% estimated by ONS for Q2 2021)  has to be balanced against  the factors laid out above. Very recent credit card data etc has shown a consumer tendency to pay down debt etc over coming months in the light of many uncertainties.

 

The minutes of the most recent MPC meeting and a speech by Andrew Bailey have reinforced the more hawkish tone, indeed suggesting the that the MPC could be ready to raise interest rates slightly as early as this week.

  

Monthly Review of Markets

Equities

Global Equities showed moderate gains over October 2021, the FTSE ALL World Index registering a climb of 4.3% in dollar terms. The UK indices, rose by between 2% and 3%, now up by about 12% since the beginning of the year. Chinese equities continued to slide, driven more by Everglade and lower economic growth estimates than prior regulatory concerns.      The VIX index fell sharply, ending the month at 16.46, a fall of 28% since the year-end. 

UK Sectors

Banks, resources, utilities and property were the standout sectors during October, the former gaining over 9% on better than expected results and higher interest rate expectations. Some more domestic sectors, however, suffered partly on renewed Covid concerns e.g. travel and leisure, which lost 6% during the month. Since the beginning of the year, UK smaller company funds have significantly outperformed equity “income” funds which have, in turn, matched the “average UK fund.”. Mixed asset funds have shown growth of between 2% and 9%, depending on the equity weight, since the beginning of the year (Source Trustnet 27th October 2021). The FTSE private client indices show similar year to date returns (Source FT 30th October)

Fixed Interest

Gilts received a boost after the unexpected Budget supply announcement after price falls over the previous weeks, the UK 10-year yield for instance finishing the month at 0.97%.  Other ten-year government bond prices showed more persistent price weakness with closing ten-year yields of 1.57%, -0.11% and 0.09% in USA, Germany, and Japan respectively. Year to date, the UK Government All-Stock Index has fallen 6.95%. Corporate bonds also rose marginally over October in price terms as did more speculative grades. Core preference shares have significantly outperformed gilts in capital terms this year, while also offering income yields in the range of 5% to 6%. 

Check my recommendations in preference shares, selected corporate bonds, floating rate bonds, zero-coupons, speculative high yield etc. A list of my top thirty income ideas from over 10 different asset classes is also available to subscribers.

Foreign Exchange

A more volatile month for currencies with sterling gaining nearly 4% against the Japanese Yen and about 1.7% against the US Dollar and the Euro. The Chinese Renminbi continues to move in a tight (semi-managed!) band versus the Dollar, finishing the month at 6. 3993. Currency moves have amplified the £ adjusted performances of overseas indices, the S&P for instance outperforming the Nikkei by around 26% so far this year in sterling terms. See my graph below for the effect of hedged Japanese exposure, in this example IJPH (brown) versus MSCI Japan(black).

Commodities

A positive month for commodity prices, especially in the area of oil, iron ore and coal (see below), the latter more Chinese driven. Gold stabilised somewhat, still in a narrow price channel for several months.

 

Looking Forward 

Notwithstanding the large human toll and uncertainly still posed by Covid-19 (lockdowns, geographical variations, vaccines) there is growing optimism regarding the longer-term course of the global economy, though the trajectories vary considerably by region. Shorter term indicators seem to point to consolidating GDP growth and higher inflation, than earlier projections, a potentially worrying combination.

Major central banks currently continue to adopt historically easy money policies, supplemented by other measures while Governments provide increasing short- and long-term fiscal support, but the medium-term rhetoric, action is clearly turning more hawkish. Interestingly, in some smaller economies where inflation/fx are more of issues, some official increase rate increases have already taken effect.

For equities, the two medium term key questions will be whether/if rising interest rates eventually cause equity derating/fund flow switches, government, corporate and household problems, and how the rate of corporate earnings growth develops after the initial snapback. At this time of writing, companies are  delivering nine month figures more than estimates, but, going forward, withdrawal of certain pandemic supports, uncertain consumer and corporate behaviour and cost pressures are likely to lead to great variations by sector and individual company. At this reporting stage corporate l statements refer repeatedly to supply chain and margin issues.

Observations/Thoughts

• At this “near” one-year anniversary of Biden victory/vaccine breakthrough, I thought it might be useful to revisit the performance of the stock “baskets” I set up, at the start of the pandemic, to review their performance during the “recovery phase”. Although my spreadsheet analysis would fail strict statistical scrutiny, the performance of about 100 shares screened by myself into buckets of balanced, high risk Covid specific and low risk, does show some useful and profitable  patterns even on a simple “buy and hold on the good news” strategy.

With the wonderful benefit of hind sight the higher risk (“vaccines to the rescue, Biden better than Trump, buy recovery”) portfolio would have shown a profit of nearly 50% in one year(November to November) with “will we ever go back the cinema,gym,cruising” names up about 70%.

The lower risk bucket, while still showing a bank and gilt busting return of 14%   lagged, and indeed Kimberley Clark (remember the loo roll shortage!),Walmart, Domino Pizza,Peleton(are those bikes gathering dust now?) and Zoom (you are still on mute!) are relatively flat or even showing losses in some cases.

The default index comparison are,FTSE +22%,S&P 30% for the same period. Gilts and Gold (safe havens!!!) massively underperformed.

Before anyone asks, looking at the stock performances from pre-pandemic highs, most UK indices are still DOWN..the FTSE was over 7500 during 2019.

Timing is everything!

 

ASSET ALLOCATION

-As well as maintaining a mildly overweight position in UK and European equities, it may be worth initiating or adding to Japanese positions within an international portfolio, perhaps by reducing overweight in USA and other Pacific. The “cheaper” stock market ratios for Japanese equities are well known (see below), while the current political change is providing a catalyst. It should be remembered that many Japanese companies provide exposure to China, but without the direct associated political risk.

The other major asset allocation decision would be to replace part of the conventional “fixed interest” portion with alternative income plays in the infrastructure, renewables, and specialist property areas. Many instruments in this area provide superior capital growth, income, and lower volatility than gilts for example.

•UK Equities remain a relative overweight in my view, based on a number of conventional investment metrics, longer term underperformance since the Brexit vote, style preference (value over growth) and a vaccine/variant mix which currently supports continued economic momentum, although be aware of the numerous  headwinds I have highlighted above. Extra due diligence at stock level will be required. Takeover activity is also clearly increasing with, for example, private equity snapping up UK-listed companies at the fastest pace for more than twenty years, WM Morrison, Sainsbury? being the most recent targets.  On current prices, the MSCI UK market PE, yield, and price book ratios on estimated 2022 figures stand at approximately 12,4.2% and 1.7 times respectively. Source: Morgan Stanley,IBES  October 2021.       

• • •Emerging Markets-Very difficult to adopt a “blanket” approach to the region even in “normal times”, but especially difficult now, with so many different COVID, commodity, debt, geo-political and increasingly natural disaster variables. Interestingly the rush into Emerging Market assets, both bonds and equities, at the start of 2021 has moderated as many dramas have unfolded e. g Turkey, India, Ukraine, Chinese regulation. This latter factor has special relevance to those using Emerging Market Benchmark Indices., most of which are currently showing negligible or even negative performance year to date. The IMF recently warned that several emerging nations could disproportionately suffer from a combination of COVID and adverse reaction to “tapering” by developed counties e.g. FX/Interest rate pressures.   Extra due diligence is required and remember to understand the currency as well as local market dynamics. One interesting point to note is that Asian/Emerging funds with an income focus are currently outperforming the more general indices, largely due to lower Chinese technology weightings.
  • •However, within the emerging space, I continue to have a relatively favourable longer term view on Asia, where relative COVID success, stable FX,inward investment and   export mix are supportive.Vietnam,South Korea and Taiwan continue to be favoured. The active versus passive debate in 2021, will take extra significance where “China versus the rest” and appropriate tech weighting will be important considerations, especially considering the recent Chinese meltdown. More caution is required in many South American markets with poor COVID-19 situations, deteriorating fiscal balances and inefficient governments, many of which are up for change. Parts of Central Europe are currently showing some resilience, especially when linked to German exports, but the Covid-19 situation is currently worsening in some areas. Russia remains an interesting contrarian play both for bonds     and equities. While the scope for political interference remains high (e.g recent elections), this is not a new story, and the economy has maintained a relatively strong position. The Index has a large natural resource weighting, and Gazprom, for instance has an 18% weighting in MSCI Russia and could be a useful natural gas hedge! India, although quite highly rated, warrants inclusion in a diversified portfolio, and is currently receiving some fund flows from “overweight” Chinese portfolios.
  • •Not on near term investor (or government!) worry lists but be aware of the huge government DEBT problem building (tax increases sooner or later). Latest figures show aggregate global debt more than GDP at the global level and the mantra of extremely low servicing costs, is just that! Sunak recently estimated that UK’s exposure to a rise of 1 percentage point across all interest rates was approximately an additional £25 billion in debt service costs, and although UK borrowing is currently emerging as better than estimated during the pandemic the actual numbers are still historically large .
  • •Apart from occasional bouts of term haven buying/liability matching, I expect conventional government FIXED INTEREST to weaken in the medium term and would not be surprised to see the US 10 Year yield to trade back towards 2.0% sometime over next months.Interestingly,most of the recent moves have been in the shorter dated paper (see below) but I would expect longer yields to resume an upward move on inflation/supply issues soon. The price moves last week in the UK gilts illustrate how “volatile” this asset class has become.
  • •However, other fixed interest options are available after, making appropriate allowance for risk, transparency, trading, liquidity etc.  for clients seeking regular income. Fixed Interest Investors may wish to prioritise more nimble tactical bond funds rather than conventional government bonds.
  • •COMMODITIES- Gold has been rangebound for several months, and while longer term inflationary reasons and diversification benefits may apply, the prospects for more cyclical plays continue to look brighter.   Increased renewable initiatives, greater infrastructure spending as well as general growth, especially from Asia, are likely to keep selected commodities in demand at the same time as certain supply constraints (weather, Covid, transport) are biting. Anecdotal evidence from reporting companies RTZ, BHP and Anglo American appear to suggest that the industry is enjoying a bumper time, and with disciplined capex programmes, extra dividends and share buy-backs are commonplace! Keep exposure to this asset class either directly or through investment trusts or ETF’s. 
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• • For contrarians, there are currently enormous opportunities for investors willing to lean against the ESG wave, a trend already apparent with many private equity deals, and hedge funds one of whom has been building stakes in tobacco companies. It may also make sense not to “abandon” the traditional oil and gas companies, which are taking big steps to realign their “carbon” policies, have financial strength and are still cheaply rated. At least one high profile London based hedge fund manager is building stakes in quoted and private oil companies.                       
• •COMMERCIAL PROPERTY-The most recent MSCI/IPD UK Property Index up to the end of September 2021 showed a monthly total return of 1.9% (25.3% annualised!) across all properties, and a year-to-date return of 11.6%(6.9% capital,4.0% income).Industrials continue to be the leading sub-sector, while in retail, warehouses are strongly outperforming shopping centres where capital values are still down about 10% year to date. Rental growth is anaemic. Continued due diligence is currently required in this sector both by asset type (direct equity, investment trust, or unit trust,) property sub-sector, and geography. Total return forecasts recently released by the IPF expect 4.4% growth in 2021 across all properties, strongly weighted to income and a provisional 7.0% figure for 2022. My view remains that investors may wish to slowly move back to a more neutral situation for the sector with my current strong preference for investment trusts rather than unit trusts. 
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