Week ended October 1st 2021
This was another difficult week in global financial markets, and the end of the most challenging month (and quarter) since the onset of the pandemic. Even so, Friday provided hope that – once again – those investors that have rescued US equities time and time again since the pandemic have not completely disappeared. As more and more brokerage firms revise their market outlooks downward and institutional investors generally remain disengaged (because of high valuations), one thing is certain – the coming weeks will continue to be choppy.
Before discussing a couple of influential news items, I did want to mention one thing in particular that also bothered me last week. During all of the gyrations in the equity and government bond markets since the pandemic, corporate credit has generally stood firm. As spreads and yields fell to record lows, investors have largely treated corporate bonds – both investment grade and high yield – as an effective placeholder, meaning a relatively safe place to park money with minimal variability. However, based on data I reviewed from last week (via FRED), corporate credit spreads gapped out, most severely in lower rated high yield. It’s true that with government bonds under pressure, this was likely going to translate into higher corporate yields sooner or later. However, I do not recall corporate spreads being under severe pressure like this for some time. This might be collateral (and ongoing) damage from Evergrande, or it might reflect a shift in sentiment amongst credit investors. It’s hard to say exactly what might be going on at the moment, but my concern is that this could prove to be an inflection point with negative implications for risk assets more broadly.
In news last week, most eyes were focused on US political events. Congress remains in virtual gridlock, mainly because the Democrats can’t seem to get out of the way of themselves as the progressive end of the party squabbles with the centre / more conservative end. The Democrats cannot muster enough support within their own party (at least not yet) to ram through the $3.5 trillion Biden-sponsored social plan via reconciliation. To make matters worse, the progressives are also holding the $550 billion infrastructure plan hostage until there is agreement on the larger social plan. Republicans held some cards in terms of the US government hitting a debt ceiling mid-October. Fortunately, this nervy item was deferred late Thursday afternoon until early December because a bipartisan Senate managed to approve a temporary reprieve. That’s one crisis deferred, or as is traditional with the US government, a can kicked down the road for “future consideration.” It all seems very messy and confusing to me, and without doubt this uncertainty is weighing on market sentiment. If I wanted to be more positive, maybe I would say that this horrible and unfortunate process is setting equities up for yet another relief rally down the road. I’m not buying that but go ahead if you wish!
Lastly before looking at market data this past week, I watched some of the Yellen and Powell grilling before the House Committee on Financial Services on Thursday. The dynamic duo had both already appeared before the Senate banking panel on Tuesday, which got plenty of press because of Elizabeth Warren’s comments to Fed Chairman Powell in which she labelled him a “dangerous man”. Maybe some of my readers find this testimony interesting, but I characterise these sorts of sessions as political grandstanding bordering on shambolic. Frankly, it is all depressing to watch, maybe because I am seeing most of it unfold in real time as I am currently in the States. What can I say? At least there is plenty of petrol and no shortage of truck drivers here, not yet anyhow! As far as markets, it was a relief to see September end because it was - for many markets - the worst month and the end of the worst quarter since the start of the pandemic. The recently high-flying Japanese market turned in the worst performance for the week, whilst the FTSE 100 provided the (relative) best performance for the second week running. All of the global indices I track were negative for the week though. For the quarter, the benchmark S&P 500 was just modestly positive for the 3Q, whilst the best performing index was the Nikkei 225 (Japan) and the worst was the MSCI EM (emerging markets).
US equities made a remarkable recovery after a dismal opening on Friday, leading all of the US indices to gains for the day. Still, it was not enough to reverse losses experienced during the first four days of the week, with all indices ending the week lower. I didn’t include monthly data in the table below, but if you want to know just how bad September was, the indices performed as follows in September: S&P 500, -4.8%; DJIA, -4.3%; Russell 2000, -3.1%; and the NASDAQ Comp, -5.3%.
It is hard to believe that 3Q21 earnings season is almost here, but it most certainly is. The six largest US banks kick off earnings as usual, reporting between October 13-15. And from there, we can expect a flood of earnings over the ensuing weeks. As investors, we need to be more attuned now than ever with what management says about guidance, and guidance is perhaps more important at current valuation levels than “looking back” at 3Q21 earnings.
Government bonds also have been under severe pressure, with yields on US Treasuries gapping out again this week before clawing back enough in the second half of the week that it masked the rather severe intra-weekly variability.
Yield increases were more pronounced at the long end of the curve as the yield curve continues to steepen. This could signal inflationary concerns, the imminent tapering or a consensus view that economic growth will continue to be robust longer. It is hard to say for sure. However, higher UST yields are almost certainly a contributing factor to the stronger US Dollar, which is continuing its march up.
It is not only the US Treasury market under pressure, but government bond market in the UK is also under pressure as you can see in the table below.
As I mentioned in the second paragraph, corporate credit yields and spreads were under pressure this week, which you can see in the tables below. This was most pronounced at the weaker end of the high yield spectrum.
As far as haven assets, gold has largely become a non-event regardless of market volatility, stuck on either side of $1,750, more or less. The US Dollar is continuing its march higher, now claiming at its expense Sterling and the Euro. Yen is also weakening relative to the US Dollar.
Like the US Dollar, oil is continuing its march higher, with some Street houses saying we might see $90/bbl soon. A stronger US Dollar could eventually have a negative effect on US economic growth, whilst higher oil prices could dampen global economic growth. The drivers remain unclear to me, because I haven’t read about any material supply side issues / disruptions, and the global economic outlook is more likely to be weaker, rather than stronger, than expected.
In the storm of turbulence that is increasing, the one asset that looks like it doesn’t care one bit is Bitcoin. It is almost behaving like a safe haven – would you have ever thought that? The benchmark cryptocurrency turned in a very solid 12.6% return for the week, and is now up over 65% YtD, far exceeding the return on any other asset class or index I track. There are a growing number of pundits saying “ignore cryptocurrencies at your peril”, but this is not a camp that I yet find myself in with any real conviction.