Barely a year after announcements of the first vaccines marked the first positive milestone in the Covid pandemic, governments and financial markets were shaken in November by the emergence of another new virus strain that exhibited markedly higher levels of transmissibility than those seen before. Happily, concerns over the human and economic cost of the rapidly spreading variant were eased by early studies indicating that, although more infectious, Omicron is far less debilitating and caused fewer hospitalisations than its dominant predecessors. Markets reverted to risk-on mode during the period’s latter stages even as central banks ramped up their hawkish narrative in response to stronger than anticipated inflation data. The quarter ended with global equity benchmarks at new highs, core sovereign bond yields little changed, commodity prices higher and the US Dollar stronger.
Equity Market Indices
|MSCI World ($)||+7.49%||+20.14%
|MSCI World (€)||+9.23%||+28.99%
|MSCI World (£)||+6.90%||+21.17%
|MSCI World (local ccy)||+7.83%||+22.45%
|S&P 500 ($)||+10.65%||+26.89%
|FTSE UK All Share (£)||+3.67%||+14.55%
|MSCI Europe ex-UK (€)||+7.45%||+22.33%
|Japan Topix (¥)||-1.86%||+10.40%
|MSCI Asia ex-Japan ($)||-1.48%||-6.36%
|MSCI Emerging Markets ($)||-1.68%||-4.59%
|MSCI Emerging Markets (€)||-0.09%||+2.44%
|MSCI Emerging Markets (£)||-2.22%||-3.77%
As shown in our table above, within the broadly positive market trend, the variations in the performance of regional benchmarks that were highlighted in our last report persisted – even more so when adjusted for currency movements – with the US the strongest performer by some distance and emerging markets continuing to struggle in both absolute and relative terms. Similar disparities were evident at a capitalisation level, with the gap between returns delivered by larger companies and those from mid- and (in particular) small caps expanding significantly when compared with recent quarters (Fig. 1). In terms of style factors, meanwhile, a rotation towards value stocks that began in late November meant that an earlier lead established by growth counters had been largely wiped out by the end of the period. All of which presented challenges to active managers throughout the period.
MSCI World vs Mid Cap vs Small Cap (USD)
Although news of the latest Covid variant and monthly inflation reports made for occasional bouts of downside volatility, economic data was, for the most part, supportive of investor sentiment and equity markets (Fig. 2). Final third quarter GDP growth of 2.3% for the US and 2.2% across the Eurozone were in line with, or marginally ahead of, consensus forecasts, whereas China’s 4.9% figure fell just short of estimates. Purchasing Managers’ Indices – the most keenly watched barometers of corporate activity – also remained at healthy levels. The latest (November) composite readings of 57.2 and 55.8 boded well for future expansion in the US and Eurozone and the December figure of 52.2 for China was a meaningful improvement when compared with recent months.
Citi G10 Economic Surprise Index
Even with the disruptive effects of the pandemic making comparisons somewhat tricky, corporate results during the quarter impressed, as reported earnings for constituents of the MSCI All Countries World Index grew by more than 25% versus the corresponding period in 2020. With consensus analysts’ estimates pricing the Index on a multiple of 18 times forward earnings at the year-end, global equity valuations remain towards the top end of the range that it has prevailed over the past thirty years.
While not even the most enthusiastic of bulls could convince us that the market is cheap, an implied price/earnings to growth (PEG) ratio of less than one does go a long way to justifying the view that, by the same token, it is by no means unattractive. Importantly, away from the highest rated US market, which dominates and skews the Index’s metrics by virtue of its 60+% weighting, valuations are far less demanding (albeit with commensurately lower growth estimates in some cases). Moreover, with M&A activity showing no sign of ending a trend that has seen deal volumes rising at a steady rate for each of the past six calendar quarters and with private equity firms reported to be sitting on up to USD 2 trillion in uncommitted cash, one can reasonably argue that there is scope for further upside based on prospective corporate activity alone. Accordingly, we remain comfortable with the current level and blend of equity allocations within our portfolios.
A quarter that ended with ten-year sovereign yields in the US, Eurozone and UK virtually unchanged (+2, -2 and -5 basis points at 1.51%, -0.18% and 0.97% respectively), was a lot more eventful for bond markets than those numbers would otherwise suggest.
The period began with yields rising against a backdrop of buoyant energy and bulk commodity prices, ongoing supply chain issues and persistent inflation data that prompted a further reassessment of the likely timetable of interest rate increases. This led in turn to a shift in maturity profiles, as short rates moved up at a faster rate than those at the longer end of the curve. The reversal in market direction that took place in November started with the Bank of England’s surprise decision to keep rates on hold, which, followed shortly after by dovish statements from the Federal Reserve, ECB and Bank of Japan caused investors to question earlier assumptions about tighter monetary conditions. Further momentum was provided by news of the Omicron Covid variant and resulting concerns over its economic impact, before selling resumed during the final stages of the quarter, as evidence of its reduced virulence, more hawkish central bank guidance and a UK rate hike triggered another (bearish) change in market sentiment. In terms of market benchmarks, the respective Bloomberg Barclays Government (>1 year) indices for the US, Germany and UK closed out the quarter up 0.17%, 0.23% and 2.53% above their opening levels.
A widening in credit spreads made for a reversal in a pattern that had seen investment grade corporate bond indices outperform their sovereign counterparts in five of the previous six calendar quarters, albeit by only a small margin. High yield benchmarks fared better in spite of those expanding spreads, reflecting the increased rates of carry on offer from sub-investment grade issues. Meanwhile, hard currency emerging market bonds, as measured by the JP Morgan EMB Index were flat for the period.
It is a measure of investors’ collective confidence in central bankers that, though by no means totally immune to its effects, bond markets’ response to a sustained rise in inflation data that continues to surprise on the upside (Fig. 3), has been quite so muted. So much so, indeed, that according to Bloomberg, real yields on US treasuries have never been lower (Fig. 4). To what extent this is justified remains to be seen and recent movements in the pricing of forward interest rates suggest that confidence is being tested more and more. Our view remains that the mix of transitory and structural influences, when combined with the embedded deflationary effects of technological advancement and demographics should result in a moderation in the historically elevated current rates to the kind of nominal rates that prevailed in the pre-quantitative easing era. Consequently, we remain comfortable with the current roster of bond fund managers within our models, which offer a combination of flexibility and specialisation that is suited to anticipated macro and market conditions.
Citi Global Inflation Surprise Index
Two year US Treasury Real Yield %
The drivers of short-term forex movements are rarely as straightforward as we would like them to be, but there was arguably a logic to the relative performance of the most heavily traded currencies this time around over the quarter under review, based on the direction of interest rates. A rate rise in the UK put Sterling ahead (+0.53%) of the US Dollar, which in turn outperformed the Euro (-1.74% in USD terms), which is expected to be the last to see an increase, except for the Yen (-3.16%). Or maybe that’s just a coincidence….
Measured in trade-weighted terms, the Dollar recorded a second consecutive positive quarter, with the DXY Spot Index closing up 1.53% at 95.67 – a little down from its intra-quarter 16-month high (Fig. 5). With only the Chinese Renminbi (+1.40%) and Indonesian Rupiah (+0.42%) as exceptions, emerging market currencies lost ground in USD terms, most prominently the crisis-stricken Turkish Lira, which recovered partially from being down 48% at one point to post a 33.13% fall over the period under review. Relatively modest by comparison were declines of 5.17% in the South African Rand, 2.58% in the Russian Rouble and 2.38% in the Brazilian Real; the JP Morgan Emerging Markets Currency Index, which we have referenced in past commentaries, was down 4.84%.
DXY Spot Index
Broad commodity benchmarks made further gains in Q4, with the Refinitiv CRB Index 1.51% higher at the quarter-end. Underlying the breadth of strength across a range of complexes (for example, Coffee+16.55%, Nickel +15.73%, Live Cattle +15.20% and Corn / Maize +10.53%) the Rogers Ex-Energy Index was up 7.70%.
For European consumers, there was good news on the energy front, as the squeeze on natural gas prices that has been the source of political anguish at domestic, regional and international level and, thanks to government-mandated price capping mechanisms, has put more than 25 UK energy providers out of business, showed signs of easing. The combination of milder weather and the redirection of ship-borne US LNG supplies originally destined for Asia saw spot gas prices retreat from levels that at one point were 91% above their opening mark to close down 23% for the quarter (Fig. 6). Though unquestionably a positive development, it’s nevertheless worth noting that the year-end price was still 368% above the corresponding figure for 2020.
Powernext Gas TTF Spot (EUR / MWh)
The coordinated release of strategic reserves in the US and Asia, together with a modest increase in OPEC+ production quotas saw crude oil prices end the quarter some way below a late October peak marked a seven-year high in the front month futures contract for West Texas Intermediate. WTI closed up just 0.24% at USD75.21 per barrel and Brent +2.26% at USD77.78.
Also down from its intra-period high, the spot Gold bullion price at least signed off with a positive tone, its closing level of USD1,829.20 per troy ounce representing a gain of 4.03%.
Download: Market Report – Q4 2021
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