October market commentary

October 2021

In summary…

Four weeks can be a long time in financial markets.  A month ago, we wrote about share markets being down in September – the worst month since the panicked Covid-19 induced selloff in March 2020.

A month on, markets have recovered, wiping out September’s losses and now sit again at or near record highs.  Have all the challenges been washed away?  We think not, but market participants are latching onto good news stories rather than any issues that may dampen sentiment.

This is an important reminder that markets fluctuate, and we shouldn’t get overly concerned about short-term returns.  Investing is a long-term game.

What happened in markets during October?

Excluding currency movements, global shares (as represented by the MSCI World Index) gained 5.5% over October, led higher by the US.  From a New Zealand investor perspective, the NZ dollar (NZD) rose after the Reserve Bank of New Zealand increased the Official Cash Rate.  A rising NZD reduces returns for NZ investors if global funds are not hedged or partially hedged.

Wall Street wrapped up the best month of the year so far.  All three major US indices, S&P 500, Nasdaq and Dow Jones finished October at record highs, with the S&P500 rallying 7.0% in the month.  European stocks jumped 4.7%, led higher by the utilities and the technology sectors.  In the UK, shares gained 2.1%.

Emerging markets did not fare as well, only gaining 0.9% as Brazilian shares tumbled 6.3%.  Concerns in the South American country escalated around a pre-election government spending splurge and potential large interest rate hikes needed to curb rampant inflation.  Towards the end of the month Brazil’s central bank announced its biggest interest rate rise in nearly two decades, a hike of 1.5%, leaving the country’s benchmark interest rate at 7.75%.

In Australia, shares fell 0.1%, while closer to home the NZX50 was down 1.3% as the Reserve Bank hiked interest rates as inflation hit decade high levels.  The impact of this increase in interest rates produced a negative return for NZ fixed interest portfolios over the month.

We came across this interesting chart which shows October share market returns across the world.  The deeper blue colours show strong returns, whereas the yellow/gold returns represent negative returns:

Market Theme 1 – Central Banks and Interest Rates

Interest rates continued to rise over the month, which generally presents a short-term negative for fixed interest portfolios.
European markets are now pricing in rate rises despite the central bank’s guidance to the contrary, with the European Central Bank (ECB) maintaining the view that inflation is transitory.  The ECB kept rates unchanged as expected

but confirmed the monthly pace of bond buying will slow in line with guidance and that the pandemic emergency purchase programme will end next March.  10-year German bunds rose 0.1% over the month.

In the US, the minutes from the Federal Reserve’s September meeting suggests it could begin reducing the pace of its monthly asset purchases as soon as mid-November.  The 10-year US Treasury bond ended 0.03% higher over October.
While most central banks around the world have begun or are planning to remove stimulus packages or tapering bond purchases, very few have started hiking interest rates.  The Reserve Bank of New Zealand (RBNZ) is part of that select group, leading the way in the tightening cycle.  After erring on the side of caution in August, the RBNZ hit the lift-off button at the beginning of October and hiked the Official Cash Rate (OCR) by 0.25% to 0.50%.  This was the first time the OCR has been hiked since July 2014.  The rate hike was later justified as inflation came in at 4.9%, surprising the market to the upside.  This saw both short and long-term government bond yields rise, with the NZ 10-year Government bond breaking through the 2.0% level for the first time since 2019, gaining 0.53% during the month to end at 2.57%.

Market Theme 2 – Is the Covid-era similar to the 1970’s?

The latest print of US economic growth showed a surprisingly sharp slowdown, caused by a large drop in consumption as the US government ended its Covid stimulus payments.

The US third-quarter GDP came in at +2.0%, the slowest gain since the pandemic-era recovery, and well down from the 6.7% achieved in the previous quarter.  Some are questioning whether the growth slowdown coming at the same time as inflation remains red hot, is a sign that stagflation (a period of slow economic growth, relatively high unemployment and high inflation) and whether a period of share market turmoil like the 1970s is around the corner. In the early-mid 1970s the Dow Jones Industrial Average index lost over 45% of its value, while the worst was felt in the UK with the market declining 73%.

The view from our investment partner BlackRock is that they do not believe we are about to experience the 1970s all over again.  The world’s largest investment manager points to the current pickup in inflation being driven by the economic restart, not rising energy prices as in the 1970s.

They point to 3 reasons why:
1.    Supply capacity has been slow to come back online, resulting in bottlenecks and price pressures;
2.    BlackRock believes growth still has room to run as the global economies continue to open up, and border constraints loosen.  Supply will eventually rise to meet demand, instead of the 1970s experience where demand fell to meet supply;
3.    Resurgent activity is currently increasing demand for oil and driving prices higher.  Again, this is the opposite of the 1970s, when higher oil prices harmed economic activity.

Our outlook…

While shares have regained positive momentum, they remain vunerable to short-term volatility.

The risks of indebted Chinese property development company Evergrande could further sour sentiment, the energy crisis in Europe and China is still to play out, central banks will start tapering soon and economies are still impacted by a raft of Covid-19 issues.

But looking through the short-term noise, even with tapering and eventual rate hikes, interest rates will remain low for the medium term.  This, alongside strong company profits and a successful vaccine rollout leading to more sustained re-openings of economies, should ultimately prove supportive over the next 12-months for shares.

Even though US and European rate hikes are still a way off, we expect bond yields to continue to rise, as the market becomes more confident that the recovery in the global economy remains on track.  Hence our outlook for fixed interest investments continues to remain less positive.

View archive of earlier market commentaries

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