Consistent with the much touted “September effect”, risk assets underperformed over the month of September, with almost all major equity indices exhibiting above-average losses. In developed markets, the MSCI World Index fell 3.6%. The drop was largely driven by US equities, with the Nasdaq losing 5.3% and the S&P 500 falling a similar 4.7%. European equities also notably underperformed, with the MSCI Europe declining 2.9%. The drop in Australian equities were less severe, with the ASX 200 falling 1.9% (Chart 1). Emerging market equities were also weaker, with the MSCI Emerging Markets Index dropping 2.8%.
Emerging market equities were also weaker, with the MSCI Emerging Markets Index dropping 2.8%. Hawkish sentiment from global central banks induced a sharp sell-off in sovereign bond markets, causing yields to jump significantly.
In the US, 10-Year Treasury yields jumped 23bps to 1.53% as investors grappled with an imminent formal tapering announcement. Likewise, Australian 10-Year Government Bond yields rose 33bps to 1.49%. Strength in the counter-cyclical US dollar resulted in a weaker Australian Dollar, which currently buys 72 US cents, 1.2% lower than in August.
Commodity markets were mixed during September. Oil markets have been driven to a 3-year high, with a sharp rally spurred by stronger demand in emerging markets and shortages across Europe. Brent Crude jumped 6.9% to $US78.50/bbl. However, concerns of slowing demand from China saw a collapse in the price of Iron Ore, which fell 24.9% to $US119/t.
Wall of Worry for Equities?
In what seems to be a ‘Wall of Worry’, a plethora of headwinds have emerged, sparking a correction in equity markets. These include the Evergrande situation, near-term Fed tapering, China slowdown, persistent supply chain disruptions, negative macroeconomic surprises, complications facing additional stimulus and debt ceiling drama in the US to name a few. The US Citi Economic Surprise Index, which measures the degree to which economic data is either beating or missing expectations – is at its lowest point in over a year, crossing over into negative territory for the first time since the depths of the Pandemic in early 2020.
However, the risk-reward profile for equities remains constructive. Relative to bonds, stocks are still priced adequately. The Global Equity Risk Premium, as measured by the excess forward earnings yield of the MSCI World Index over real government bond yields is currently 6.2%. In the more expensive US market, this stands at 5.8%.
Is Evergrande China’s ‘Lehman Moment’?
One of China’s largest and most aggressively levered property developers, Evergrande Group, is currently experiencing significant liquidity pressures. With limited cash on its balance sheet, Evergrande has missed an $83m coupon payment due on 23 September and a $47m payment due on 29 September. Evergrande must also make coupon payments for offshore bonds totalling $547m by 28 December this year. While highly leveraged, we do not feel Evergrande poses a systematic risk. Evergrande has 1.4bn RMB of land and property sitting on its balance sheet which can be sold to reduce leverage and meet its obligations. In fact, a state-owned asset manager recently purchased a 19.9% stake of Shengjing Bank from Evergrande for $1.5bn. In addition, several reports have noted that regulators last week have urged banks to support Evergrande. We expect more strategic investors to come in under government direction and assist with a restructure of the property developer.
Furthermore, the Chinese government has a firm control over the financial system and avoiding systematic risk is a top priority. The People’s Bank of China has been injecting liquidity into the system to prevent a market liquidity squeeze. There is also a possibility that China may announce a stimulus package to cushion the economy should it need to do so. Thus, it is unlikely that the Evergrande debacle will turn out to be China’s ‘Lehman Moment’ – The Chinese authorities have the tools at their disposal to prevent this from eventuating.
We remain positive on equities in the medium-term. Our base case is for availability and adoption of vaccines to allow for global economic re-opening, further supported by accommodative fiscal and monetary policy. This will lead to above-trend growth, driving strong medium-term earnings growth and pushing equities higher. There are a number of factors that may contribute to near-term uncertainty in equity markets, however, we feel this would present an opportunity to buy quality assets at dampened valuations.
Long-term inflation presents a risk that portfolios need protection from, which can be gained through holdings in property, infrastructure, and gold.
We continue to see government bonds as largely un-investable and prefer various alternative investments that add diversification to portfolios whilst also helping to achieve income and growth targets.
We encourage you to contact us should you wish to discuss this further or if you have any questions about how these trends are impacting your portfolio.