Tapering…off

After a challenging July, emerging market equities bounced back in the second half of August to deliver monthly gains in line with developed market equities. Despite the outperformance of UK and European small caps, large caps marginally outperformed their small caps counterparts globally as outsized gains from US large caps skewed aggregate returns. In terms of style, global growth continued to outperform global value in August, but value names remain ahead year-to-date.

All major regional equity markets delivered positive returns in August. As jitters around China’s regulatory crackdown eased, Chinese A shares rallied as investors took advantage of the recent drawdowns. Meanwhile, US tech stocks benefited from positive earnings results, with the tech-heavy NASDAQ indices leading the gains. Japanese equities also posted solid gains in August, with a robust corporate sector offsetting political uncertainty and rising COVID-19 infections. In the UK, small- and mid-cap stocks outperformed FTSE 100 large cap names. Equity returns in Europe and Asia ex Japan lagged the wider market, impacted to some extent by concerns about the spread of the COVID-19 Delta variant and slowing growth in China. However, both regions managed to secure positive returns overall. 

In commodities, softer demand sent Brent crude to near $65/barrel in the month, before it recovered ground to finish around $72/barrel. It remains up around 40% year to date. Gold finished relatively flat in August after a strong July, while the US dollar marginally strengthened against a basket of currencies. 

Government bonds sold off in August. US treasuries finished marginally down after better-than-expected non-farm payrolls and due to some nervousness around a potential announcement on asset purchase tapering in the run up to Fed Chair Jerome Powell’s Jackson Hole speech. While signalling a likely reduction in bond purchases before year end, Chair Powell struck a fairly dovish tone overall, stating that while ‘substantial further progress’ has been made on the central bank’s goals, any interest rate hikes would be subject to more stringent hurdles around maximum employment and labour market stability.  

German bunds declined on tapering concerns after higher energy costs and supply-chain bottlenecks drove year-on-year eurozone inflation to its highest level in almost a decade, with harmonised CPI sitting at 3% in August – up from 2.2% in July. UK gilts also sold off in the final week of August, following a rise in yields earlier in the month after the Bank of England’s Governor Bailey set out the central bank’s roadmap for ‘modest’ quantitative tightening.

Rising bond yields and a recovery in revenues supported financials in the month, and there were further earnings-driven gains in the information technology and communication services sectors. We also saw some defensive rotation into utilities and healthcare amid ‘peak growth’ concerns. Supply chain bottlenecks and weaker commodity prices weighed on the materials and energy sectors in August. However, energy stocks remain among the strongest performers year to date.

While markets have taken inflation concerns in their stride in August, and investors’ fears of near-term monetary policy tightening have ‘tapered off’ for now, market participants will be digesting the recent actions taken by the ECB – maintaining ‘favourable financing conditions’ but with a ‘moderately lower pace of net asset purchases’ – and looking to the US for the next Federal Open Market Committee (FOMC) meeting in September to gauge any change in central bank tone.

A good deal of uncertainty remains, creating potential headwinds to the durability of the global economic revival. Wariness about the spread of COVID-19 variants and concerns about vaccine efficacy could weigh on confidence moving forward. 

Softer economic data more recently has highlighted some weakness in consumer sentiment and a slowdown in retail sales, exacerbated by remaining or reinstated travel restrictions to combat the spread of coronavirus variants. However, economic data is backward-looking and traditional measures can be narrow in focus and distorted by a number of factors, so gauging current trends (and the transitory or more enduring nature of these) can be tricky.

Increasingly, the use of high-frequency data is being adopted to try and paint a more accurate picture of the current health of the economy. In the UK, for example, looking at consumer demand, official ONS data showed month-on-month retail sales down 2.5% in July, yet Barclaycard reported a jump in entertainment spending in July as people returned to cinemas, theatres and sports events¹. The latter observation was mirrored by Google mobility data, while OpenTable recorded a steady uptick in UK restaurant bookings².

In ‘following the data’, central bankers have much to sift through to assess the health of the global economy, but mixed economic signals are adding another layer of complexity. The challenge lies in navigating the myriad of variables which could either derail the recovery or, indeed, turbo charge it, leading to rampant price rises and an inflation overshoot.

The balancing act for central banks moving forward will be to maintain investor confidence while unwinding their balance sheets and weaning the market off monetary stimulus. A well-flagged roadmap and tapering of bond purchases in advance of actual policy tightening and interest rate hikes, could be just the tonic. 

¹ https://www.reuters.com/world/uk/uk-retail-sales-unexpectedly-fall-sharply-july-2021-08-20/
² https://www.ft.com/content/72fd6c74-61ed-49d0-9adc-de1cbd4a2b10