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BMO Global Asset Management – Investing in the time of COVID

Please see article below from BMO Global Asset Management – received yesterday 14/10/2021

Steven Bell monthly update – Investing in the time of COVID

Despite the success of vaccines, the virus may put pressure on hospitals in the northern hemisphere as winter sets in; these are headwinds for equities and we could see a 5-10% correction before year end.

The global economic recovery has run into a string of supply shortages, from natural gas to key workers to silicon chips. Inflation has risen. Central banks still maintain that it is temporary, but the pressures are such that the Bank of England and US Federal Reserve may have to raise rates earlier than the market had expected. Despite the success of vaccines, the virus may put pressure on hospitals in the northern hemisphere as winter sets in; these are headwinds for equities, and we could see a 5-10% correction before year end. But the longer-term outlook for risk assets is positive with a notable capex boom likely to boost productivity and corporate earnings.

• Vaccination rates are higher in Europe but the indoor season is approaching for northern countries too, so expect another wave of hospitalisations.
• The UK is enjoying an improvement in new cases, new hospital admissions haven’t risen as fast as expected recently, especially in England. But there are still far more people in hospital with Covid in the UK on a per capita basis than most European countries. Double the number in France and five times those in Italy, Germany and the Netherlands.
• Covid precautions have reduced the number of available beds in the UK by 6,000, and we started off with fewer beds per capita than most other developed market countries. The crisis here is far from over.
• The crisis at Evergrande is a symptom of a wider structural change. China is weaning itself off a credit-fuelled construction boom with Beijing preferring ‘quality’ over ‘quantity’ in terms of economic growth.
• An energy crisis is leading to shutdowns in key sectors; the economy is slowing.
• A policy response is coming but it has been delayed by inflation concerns and the desire to avoid further fuelling excessive credit growth.

• Used car and car rental prices have started to ease in the US, signalling that some bottleneck price pressures are beginning to ease.
• Having increased over the past 12 months, US inflation expectations have now stabilised at around 2%.
• But signs of a pick-up in wages suggest that either profit margins are squeezed or that inflation could stay high for longer.
• Although analysts forecasts for Q3 US company earnings look too low, they also haven’t fully factored in the impending corporation tax increase, and earlier-than expected rate hikes due to rising wages will squeeze profit margins. We could see a 5-10% correction in markets before year end.
• Equity markets have stumbled recently as developed market central banks have suggested that official interest rates could be headed higher sooner than markets expect.
• However, a boom in capex orders in the US and elsewhere is a major positive for the longer term, boosting productivity and corporate earnings.

Please continue to check back for our latest blog posts and updates.

Charlotte Clarke


15/10/2021

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Brooks Macdonald – Daily Investment Bulletin

Please see below Daily Investment Bulletin received from Brooks Macdonald yesterday, which provides a pertinent update on the markets, with reference to supply shortages and transitory inflation.

What has happened

US and European equity indices recorded small losses as investors looked ahead to today’s US CPI release and the start of the US earnings season. There was plenty of movement within government bond yields with the US 10-year Treasury yield now off its recent highs, trading at 1.58% ahead of the key inflation data point today.

Fedspeak and inflation

Vice Chair Clarida will shortly end his term at the Federal Reserve but yesterday signalled that the time was approaching for a tapering announcement. Clarida followed the transitory inflation narrative but recognised market concerns that inflation risks are now poised to the upside rather than the downside. Atlanta Fed President Bostic, who is known to harbour more hawkish views, said that price pressures were spreading amongst the CPI basket and that they looked more entrenched than previously believed. Today’s CPI figures are the last inflation release before the Federal Reserve considers monetary policy in their November meeting. Market expectations are for Core CPI to hold steady at 4% year on year and for CPI to also mirror the last release at 5.3%. It will take some months for the recent run up in energy, used cars and commodity prices to come into the data which may mean a downside miss on these numbers is shrugged off by a more hawkish market.

Apple and Semiconductors

One of the highest profile shortages during the pandemic has been semi-conductors and yesterday Bloomberg reported that Apple was struggling to acquire sufficient chips to meet its iPhone production targets. There was hope in recent months that more supply would come online to meet the surge in demand however this is yet to filter through to production creating fears that the problems will continue well into 2022. A lack of availability of chips has also catalysed another leg higher in used car prices over the last month and looks set to continue to cloud the inflation picture for Q4.

What does Brooks Macdonald think

The chip shortage is reducing the supply capacity of most technology hardware suppliers and auto manufacturers. The shortage risks reducing economic output as well as creating inflation which will place further pressure on central banks to raise rates ahead of the risk of stickier inflation.

Please check in with us again soon for more relevant content and news.

Stay safe.

Chloe

14/10/2021

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Stocks rise as wholesale gas prices hit record high

Please find below, an update received from Brewin Dolphin yesterday, on how the increase in prices for wholesale gas have impacted stock markets.

Most major stock markets ended last week in the green after a volatile few days that saw wholesale gas prices hit record highs.

 The S&P 500 gained 0.8% as the rise in UK and European gas prices boosted energy stocks. The Dow ended the week up 1.2%, with stocks rallying on Thursday amid reports that the Senate had passed a bill to raise the debt ceiling and enable the government to keep paying its bills through early December.

The pan-European STOXX 600 and the UK’s FTSE 100 both added 1.0% as fears about the impact of rising energy prices eased throughout the week.

In contrast, Japan’s Nikkei 225 slumped 2.5% on concerns that new prime minister Fumio Kishida would increase capital gains tax in an attempt to rectify wealth disparities.

 Last week’s market performance*

• FTSE 100: +0.97%

• S&P 500: +0.79%

• Dow: +1.22%

• Nasdaq: +0.09%

• Dax: +0.33%

• Hang Seng1 : +1.07%

• Shanghai Composite2 : +0.67%

• Nikkei: -2.51%

* Data from close on Friday 1 October to close of business on Friday 8 October.

 Closed Friday 1 October.

Closed Friday 1 October to Thursday 7 October.

Wall Street slips on inflation concerns

US indices fell on Monday (11 October) as fears about inflation and supply chain constraints continued to weigh on investor sentiment. The S&P 500, Dow and Nasdaq all lost 0.7% as the surge in oil prices fuelled concerns about tighter monetary policy. In contrast, the FTSE 100 gained 0.7%, boosted by strong performance in its large mining sector.

UK and European indices started Tuesday in the red, with the FTSE 100 and the STOXX 600 down 0.8% as investors mulled the latest UK jobs data. Figures from the Office for National Statistics showed that while unemployment fell to 4.5% in the three months to August, vacancies rose to a record high of 1.2 million, indicating that companies are struggling to fill jobs.

Investors are looking ahead to this week’s US inflation and retail sales figures, and for any signs of ‘stagflation’ – a period of high inflation and unemployment coupled with slow economic growth.

Wholesale gas prices soar

UK wholesale gas prices hit a new all-time high on Wednesday, surging by nearly 40% in just 24 hours. High global demand and reduced supply has seen prices soar this year, resulting in several UK energy firms collapsing. Prices subsequently fell back after Russia’s president Vladimir Putin said the country would help to ease the crisis by boosting supplies to Europe.

UK gas prices Markets

There are concerns higher prices will lead to unaffordable bills for some businesses, especially those requiring heat as part of their production processes. This could result in lower production, factory closures and unemployment. Businesses could also pass on higher energy bills to consumers, thereby squeezing household finances.

Europe has also seen rising gas prices, but European Central Bank president Christine Lagarde said last week that policymakers should not ‘overreact’ to rising energy prices or supply shortages because ‘our monetary policy cannot directly affect those phenomena’. Minutes of the ECB’s September meeting, reported by the Financial Times, showed some policymakers were concerned about ‘upside risks’ to inflation and had called for a bigger cut in asset prices than was ultimately decided. Policymakers said inflation could exceed the ECB forecasts ‘if a different path materialised for oil prices’ and if supply chain issues lasted longer than expected.

 US payrolls miss expectations

Last week also saw the release of the closely watched US nonfarm payrolls report, which showed payrolls rose by 194,000 in September – well below the Dow Jones estimate of 500,000. This followed an upwardly revised gain of 366,000 in August, according to the Labor Department.

Several newspapers are speculating about whether the jobs report could encourage the Federal Reserve to start tapering its support for the economy. The Fed previously said it would continue its current asset purchasing programme until there was substantial further progress on two goals: inflation averaging around 2% and maximum employment.

Although the headline payrolls figure missed expectations, other aspects of the jobs report were more positive. For example, whereas the number of Americans on government payroll fell by 123,000, there was a 317,000 increase among those on private payrolls, suggesting hiring strength in the private sector. Meanwhile, the unemployment rate fell to 4.8%, the lowest since February 2020 and better than the expected 5.1%.

New Japanese PM takes office

Over in Asia, Fumio Kishida, who won the leadership race for Japan’s ruling Liberal Democrat Party, was confirmed as the country’s new prime minister. This was thought to be one of the reasons behind last week’s slump in Japanese stocks, with investors rattled by suggestions that Kishida might push for an increase in capital gains tax. On Sunday, however, Kishida announced that he had no such plans for the time being, and that he would pursue other steps to rectify wealth disparities first.  To view the latest Markets in a Minute video click here

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

David Purcell – Operations Administrator

13th October 2021

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The social factor – unfairly underrated

Please see the below article from JP Morgan received yesterday morning:

Environmental, social and governance (ESG) factors have all grown in importance for investors in recent years. But the S in ESG – the social factor – has, until recently, often played second fiddle to environmental considerations.

This neglect is understandable, because what makes up the social factor – how well companies treat their employees, suppliers and customers – is harder to measure than performance on the environment or in governance. Nonetheless, failing to pay heed to the social factor is a mistake because there appears to be some correlation between social performance and share price performance.

The benefits of happy employees

One way to measure this correlation is by looking at Glassdoor, the website where employees anonymously rate employers. Over the past 10 years, the share prices of companies ranked in the top fifth in Glassdoor ratings have outperformed companies ranked in the bottom fifth by over 6%. Glassdoor provides useful quantitative and qualitative evidence, so it can help open the door to engagement with management on social issues. We used Glassdoor, for example, to start a conversation with a management team about issues employees were raising on the platform. This prompted a productive discussion with senior executives about what they thought they could do to address these issues.

Exhibit 1: Glassdoor versus returns

This glassdoor model is a proprietary neural network, which was trained to forecast future financial performance from content in Glassdoor reviews. The model was trained in an expanding window manner, using 5 million reviews from more than 5,000 unique publicly-traded companies, covering the time period from 2008 to present. For more information please refer to footnote.

Another example of how employee satisfaction can contribute to a better company is Rentokil Initial, a British pest-control and hygiene company. The company has a strong culture of listening to employees; this has likely contributed to its high employee retention rate of 85%. Importantly, customer retention is equally high at 86%, supporting the idea that happier employees produce more satisfied customers because the workers tend do their jobs better.

The value of customer service

Treating customers well is another social factor that can also have an impact on company performance, as evidenced by the recent issue of travel refunds thrown up by the pandemic. Customers who booked directly with a hotel or airline found it easier to secure a refund than if they had booked through a third party. We believe that this may translate into an increase in direct bookings, which allows us to try to capture and quantify the differences in customer service by feeding these expected new booking trends into our earnings growth estimates.

Diversity in focus

Treating employees and customers well is one way companies are taking the social factor more seriously. The corporate sector, as a whole, also seems to be paying more attention to social factors. For example, since early 2020 there has been a sharp rise in the number of management mentions of diversity and inclusion in the earnings calls of companies in the MSCI All Country World Index.

Exhibit 2: The importance of social issues in ESG investing

Corporate mentions of “diversity”/“inclusion” in earnings calls

Number of mentions for MSCI ACWI companies, four-quarter moving average

Studies have started to examine the impact diversity on corporate performance. A 2018 study by McKinsey found that companies in the top quartile for gender diversity on executive teams were 21% more likely to outperform on profitability and 27% more likely to have superior value creation, while companies in the top quartile for ethnic/cultural diversity on executive teams were 33% more likely to have industry-leading profitability.

Conclusion

We believe increased corporate focus on social factors will ultimately be good for productivity, economic growth and – in the long term – corporate profits and share prices. We see much for investors to celebrate in the future if the social factor is good for share prices.

Comment

Its an interesting area to improve businesses in the UK. For large corporates like Rentokil Initial, you can see how they can drive change through the business. Is this more challenging for smaller companies?

Keep checking back for our usual market updates, insights and ESG related content.

Andrew Lloyd DipPFS

12/10/2021

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AJ Bell: Why the dollar must be watched

Please see below for one of AJ Bell’s latest articles received by us yesterday 10/10/2021, looking at the importance of the US Dollar to Global Markets:

The International Monetary Fund’s quarterly Composition of Official Foreign Exchange Reserves report may not be everyone’s idea of bedtime reading but one trend immediately emerges from the latest data. The dollar is still – slowly – falling from favour as the globe’s reserve currency with non-US central banks.

As of June 2021, the dollar represented 59% of global exchange reserves, only a fraction above December’s 25-year low and way down from this century’s 73% peak, reached in 2001.

The creation of the euro may have something to do with this and the rise of the Chinese renminbi may be another, while the US may not have helped its cause with rampant deficit creation and money printing since 2009 (even if it is not on its own in either respect).

This has perhaps tempted some central banks to sell dollars in exchange for something else (gold or other currencies), because the greenback trades well below its early-century highs, as measured by the trade-weighted DXY index. The so-called ‘Dixie’ benchmark currently stands at 94 compare to its 2002 peak (for this century) of 120.2.

This may feed into the ‘demise of the dollar’ narrative that is popular with some economists and investors (even if that neglects the lack of credible alternatives, especially as the Chinese renminbi still represents just 2.6% of global foreign reserves). Yet for all of that, the DXY index trades at its highest mark for 2021 and all market participants, not just currency traders, will know that attention must be paid when the US currency starts to make a move, up or down.

Dollar dynamic

Two asset classes are particular sensitive to the dollar, at least if history is any guide.

The first is commodities. All major raw materials, except cocoa (which is traded in sterling) are priced in dollars. If the US currency rises then that makes them more expensive to buy for those nations whose currency is not the dollar or is not pegged to it and that can dampen demand, or so the theory goes.

While the past is by no means a guarantee for the future, it can be argued that there is an inverse relationship between ‘Dixie’ and the Bloomberg Commodity Price index.

The second is emerging equity markets. They do not appear to welcome a strong dollar either, judging by the inverse relationship which seems to exist between the DXY and MSCI Emerging Markets benchmarks. Dollar strength at the very least coincided with major swoons in EM, or at least periods of marked underperformance relative to developed markets, during 1995-2000 and 2012-15. Retreats in the greenback, by contrast, appeared to give impetus to emerging equity arenas in 2003-07, 2009-12 and 2017-18.

This also makes sense, in that many emerging (and frontier) nations borrow in dollars and weakness in their currency relative to the American one makes it more expensive to pay the coupons and eventually repay the original loans.

Sovereign defaults are thankfully few and far between in 2021 – Suriname and Belize are the only ones that spring to mind – but a rising dollar could put more pressure on potential strugglers whose credit ratings continue to slip, notably Tunisia.

Bouncy buck

But before investors jump on the dollar bandwagon – and to conclusions – it must be worth asking why the US currency is back on a roll, and there are a couple of possibilities here.

The first is risk aversion. It may seem strange to say this as so many equity markets trade at or near all-time highs and so many sub-classes of the bond market offer record-low yields, but it may not be entirely a coincidence that the S&P 500 index has just served up its weakest month since the outbreak of the pandemic.

China’s regulatory crackdown, and signs of an accompanying economic slowdown, may be tempting some investors to seek out a haven asset and the dollar, as the globe’s reserve currency, still fits that bill.

The good news here is that the DXY index is nowhere its all-time high of 160 in the mid-1980s (a situation that was only resolved by 1985’s Plaza Accord, when the G5 unilaterally revalued the deutschmark, as they were then, against the US currency), let alone that 120 peak of 2002, but substantial further dollar gains could be a warning of a market dislocation of some kind.

The second is US monetary policy. Whether you believe it or not, the US Federal Reserve is again discussing the prospect of tapering quantitative easing and raising interest rates in either 2022 or 2023.

Real US interest rates, adjusting for inflation, are as deeply in negative territory now as they have been for 50 years, thanks to record-low interest rates and a 5.2% inflation reading. History suggests a move upward, either due to lower inflation, higher borrowing costs or both, could boost the buck.

Yet the sensitivity of the emerging markets and commodity prices to sharp moves in the dollar suggests the Fed will have to move carefully, as the US central bank will not wish to cause – or be blamed – for the sort of upset which is now known as 2013’s taper tantrum. If monetary policy does become less loose, it seems sensible to expect higher volatility at the very least.

Please continue to utilise these blogs and expert insights to keep your own holistic view of the market up to date.

Keep safe and well

Paul Green DipFA

11/10/2021

Team No Comments

Why are bond yields rising and what does it mean for stocks?

Please see below an article from A.J. Bell, which was received late yesterday (07/10/2021) afternoon which cover their thoughts on what effect rising bond yields will have on stocks:

As you can see from the above, rising interest rates aren’t necessarily a bad thing for cash assets and banks, although, this will lead to debt becoming more expensive. I believe that this will be something the UK Government will be reluctant to implement until absolutely necessary. Cheap debt is what has helped the Government support the country financially during the Covid pandemic.

Another thing to note is that if interest rates do increase, growth stocks could become less attractive as investors seek investments that have a higher equity risk ratio and may generate higher investment returns.

For the majority of our clients, the Fund Managers will switch between sectors on your behalf.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Please keep safe and healthy.

Carl Mitchell – Dip PFS

Independent Financial Adviser

08/10/2021

Team No Comments

Brooks Macdonald – Daily Investment Bulletin

Please see investment bulletin below from Brooks Macdonald received yesterday – 06/10/2021

What has happened

Yesterday saw some stabilisation within equity markets however the start to the European trading session today has seen a good portion of the gains dissipate. Inflation remains the key topic and expectations increased again yesterday, catalysing weakness in bond markets.

Gas and Inflation

European natural gas futures surged by another 20% yesterday and have seen a more than six-fold increase since the start of 2021. The European natural gas market continues to have some of the most impressive price increases however US gas futures and oil also continued to rise as inflationary pressures continue in the commodity and energy space. All of this has translated into rising 10-year inflation expectations which are now just shy of 4% in the UK (using RPI) and 2.5% in the US (using CPI). Bonds yields rose in response, with the US 10-Year Treasury yield at 1.55% today and 10-year gilt yield at 1.14%, both a far cry from their levels in August. Despite this, equities rose with the technology heavyweights leading the charge after a weaker start to the week however taking the last few weeks in aggregate it is clear that these inflation concerns are weighing on risk appetite more generally.

US Politics

The US Senate will vote today on the suspension of the US debt ceiling however it is widely expected to be blocked by the Republicans given the comments on recent weeks. Senator Manchin (a key Democrat moderate) is said to be warming to a social infrastructure bill worth around $2tn (from the original $3.5tn) so there are signs that a consensus is starting to form ahead of the reconciliation bill which may need to include the debt ceiling and the ‘Build Back Better’ economic plan. Meanwhile on the race for the next Federal Reserve Chair, Senator Warren is positioning against the reconfirmation of Chair Powell with criticism that the incumbent ‘failed as a leader’. Financial betting markets are now pricing in a far more open field for this important role.

What does Brooks Macdonald think

The latest surge in energy prices puts further pressure on the transitory inflation narrative with inflation expectations increasing over the medium to longer term. Yesterday the Reserve Bank of New Zealand rose rates by 25bps joining the small, but growing, group of central banks responding to the inflationary pressures. Yesterday’s US composite PMI data was the weakest we’ve seen this year suggesting that, at the same time as we see inflation rising, growth momentum is slowing, posing further challenges to policymakers.

Bloomberg as at 06/10/2021. TR denotes Net Total Return

Another quick update from Brooks Macdonald, these regular investment bulletins help us keep up to date with what is happening in the markets.

Please continue to check back for our latest blog posts and updates.

Charlotte Clarke

07/10/2021

Team No Comments

Stocks slump amid high inflation and slowing growth

Please see below ‘Markets in a Minute’ article received from Brewin Dolphin yesterday evening, which provides analysis of the markets’ reaction to high inflation, despite the widely held opinion that it is transitory and will subside.

Most major stock markets fell sharply last week as fears about rising inflation and slowing economic growth weighed on investor sentiment.

The pan-European STOXX 600 tumbled 2.2% as eurozone consumer prices jumped to their highest level since September 2008. The FTSE 100 slipped 0.4% after the Bank of England’s governor said UK gross domestic product (GDP) would not recover to pre-pandemic levels until early next year.

In the US, the S&P 500 fell 2.2% amid uncertainty around the raising of the debt ceiling and difficulties surrounding the passing of the $1trn infrastructure bill. Reports of supply constraints also drove several companies’ share prices lower.

The gloomy mood spread into Asia, where Japan’s Nikkei 225 crashed 4.9% and China’s Shanghai Composite ended its holiday-shortened trading week down 1.2%.

Tech stocks drag Wall Street lower

Equities started this week in the red, with the S&P 500 and the Nasdaq down 1.3% and 2.1%, respectively, on Monday (4 October) driven by a rotation out of technology stocks and rising bond yields. Shares in Facebook tumbled 4.9% as its Instagram, WhatsApp and Facebook services suffered outages.

The selloff weighed on UK and European indices, which had already been dragged down earlier in the day by the announcement that trading in Evergrande shares had been suspended. The decision by OPEC+ to raise crude oil output by 400,000 barrels a day in November was also in focus.

On Tuesday, the FTSE 100 appeared to have shaken off Wall Street’s wobble, gaining 0.6% at the start of trading.

Eurozone inflation hits 13-year high

Figures released last week revealed the impact that soaring energy prices are having on inflation in the eurozone. In September, inflation accelerated to an annual pace of 3.4%, the highest level since 2008 and above the 3.3% forecast by economists. Energy costs were the biggest driver, soaring by 17% year-on-year. Core inflation, which strips out food and energy prices, also hit a 13-year high of 1.9%, according to the data from Eurostat.

Christine Lagarde, president of the European Central Bank, told the European Parliament earlier in the week that inflation could exceed the central bank’s forecasts, which have already been increased twice this year. “While inflation could prove weaker than foreseen if economic activity were to be affected by a renewed tightening of restrictions, there are some factors that could lead to stronger price pressures than are currently expected,” she said.

Nevertheless, Lagarde stuck to the official forecast that high inflation would prove transitory and that the rebound in energy prices and supply chain bottlenecks would ease in 2022.

It came after data showed German consumer prices rose by 4.1% in September from a year ago – the highest level in almost 30 years.

UK economic recovery delayed

The supply chain crisis means the UK’s economic recovery is likely to be delayed. Bank of England governor Andrew Bailey said GDP will not recover to pre-pandemic levels until early next year – up to two months later than was anticipated in August. He added that the Bank would keep a close watch on inflation expectations and the labour market.

Figures from the Office for National Statistics (ONS) showed GDP surged by 5.5% in the April to June quarter, better than its initial estimate of a 4.8% increase. The ONS said there were increases in all main components of expenditure, with the largest from household consumption following the easing of coronavirus restrictions.

However, monthly ONS figures showed the recovery largely stalled in July, growing by an estimated 0.1% from the previous month. There are concerns consumers will tighten their belts in the face of rising energy bills.

US consumer confidence falls

Over in the US, consumer confidence dropped in September for a third consecutive month, as the spread of the Delta variant and higher prices continued to dampen sentiment. The Conference Board’s index fell to 109.3 from a revised 115.2 in August, the lowest in seven months and far worse than the 115.0 expected by economists in a Bloomberg survey.

The present situation index, based on consumers’ assessment of current business and labour market conditions, fell to 143.4 from 148.9 and the expectations index, based on consumers’ short-term outlook for income, business and labour market conditions, fell to 86.6 from 92.8.

This came after the University of Michigan’s preliminary consumer sentiment index edged up in early September but remained close to a near-decade low. The report said high prices drove the declines in buying conditions for durable goods such as appliances and cars, adding “consumers have become much more concerned about rising inflation and slower wage growth and their negative impact on their living standards.”

Despite this, consumer spending rebounded by 0.8% in August following a 0.1% decline in July, according to the Commerce Department. The personal consumption expenditures (PCE) price gauge, which the Federal Reserve uses for its inflation target, rose by 0.4% from a month earlier and by 4.3% from a year earlier – the largest annual increase since 1991.

Please check in again with us soon for further news and relevant content.

Stay safe.

Chloe

06/10/2021

Team No Comments

Weekly Market Performance Update

Please find below, an update on market performance, received from Invesco yesterday.

A number of competing macroeconomic factors have been at play in recent months that have impacted financial markets. While vaccination rates continued to rise, the spread of the Delta variant has seen a large increase in new Covid cases, which saw further containment measures, notably in “zero-tolerance” countries, such as China. Despite that there was a general trend towards a further re-opening of economies and a return to normality. However, PMIs have been weakening as the pace of the recovery slows. Talk of a period of stagflation has increased, with inflation having risen sharply as base effects, supply chain issues and labour shortages have all impacted. While most Central Bankers and economists see the inflation risk as transitory, the underlying trend in monetary policy is for the removal of some of the extraordinary support that has been put in place over the past 18 months, led by tapering and ending of asset purchase programmes and rate hikes in due course. Concerns around US fiscal policy and the debt ceiling were increasingly in focus towards the end of the quarter. In China regulatory pressures and the fate of Evergrande, the second largest property developer, also weighed on investor market sentiment. Against this backdrop it was hardly surprising that financial markets have generally found it much tougher going as we approach autumn.

Not even a strong rally on Wall Street on Friday was enough to prevent global equities from having their worst week (MSCI ACWI -2.2%) since February. With China ending the week with small gains (MSCI China 0.4%) this limited EM losses (-1.1%) and ensured outperformance relative to DM (-2.3%). EM EMEA continued to benefit from rising Energy prices, rising 1.1% and leaving it up 22% YTD. Within DM weakness was across the board with Japan (-4.3%) and Europe ex UK (-2.6%) seeing the worst of the major market declines. Small Caps (-1.5%) outperformed slightly with DM and EM performing in-line. At a sector level performance was again dominated by Energy (4.6%) and it is now up 37.1% YTD, leaving it just over 13% ahead of the next best sector, Financials, which also had a good relative performance week (-0.1%). Underperformers were led by IT (-4.1%) and Health Care (-3.2%). Sector mix ensured that Value had a very strong week relative to Growth, falling just -0.9% compared to -3.4%. Rising yields have hurt long-duration assets. Quality (-3.4%) also had a tough week. UK equities had another strong relative week with the All Share down just -0.8% on the back of large cap outperformance (FTSE 100 -0.3%), as mid (FTSE 250 -2.7%) and small caps (FTSE Sm Caps -2%) struggled. Performance was boosted by a very strong Energy sector (6.9%), while Basic Materials (0.1%) also eked out a small gain. Industrials (-3.7%) and Utilities (-2.4%) were the main laggards.

Government bond yields were generally biased higher, albeit the moves in the UST and EZ bonds were marginal. The largest DM rise was in Gilts where the 10yr rose 8bp to close at 1%, its first time at that level since May 2019. It is now up 81bp since the start of the year. A further -1.5% for the Gilt index during the week left it down -7.6% YTD. Weak Gilts spread into £ IG with yields rising 10bp and the YTM above 2% for the first time since mid-2020. Yields rose less in US and Euro IG, with commensurate better relative performance. In HY, yields also rose 10-11bp across the board, but shorter duration meant that the sector outperformed IG, albeit still suffered small losses.

The US$ hit a one-year high during the week ending with the US Dollar Index seeing a gain of 0.8%, leaving it up 3.6% YTD. Both £ and the Euro lost 1%, with both close to their YTD lows. EM currencies also weakened with the JPM Emerging Market Currency Index down -0.5%, leaving it -4% YTD.

In commodities the Bloomberg Commodity Spot Index gained 2% and is now up 28.8% YTD. Energy (4.8%) and Softs (4%) led the gains again. While Oil prices saw a modest gain (1.5%) Natural Gas continued its sharp rise higher with an 8% gain. Industrial Metals struggled with Copper falling -2.2% and at 17.9% YTD is well below its 34.8% high. A contraction in the Chinese Manufacturing PMI for the first time in 19 months and a stronger US$ weighed. Gold eked out a small positive return (0.2%) its first in four weeks but is still down -7.5% YTD. Silver’s woes, however, have been far greater. It is down -14.6%.

Market performance last week (%)

Past performance is not a guide to future returns. Sources: Datastream as at 3 October 2021. See important information for details of the indices used.1

YTD market performance (%)

Past performance is not a guide to future returns. Sources: Datastream as at 3 October 2021. See important information for details of the indices used.1

Chart of the week: ICE UK Natural Gas NBP Futures (US$/MMBtu)

Past performance is not a guide to future returns. Source: Datastream as at 2 October 2021.

  • There have been some spectacular moves in commodity prices this year and none more so than what has happened to natural gas prices, particularly in the UK and Europe. In the UK the ICE future for the current month has risen 490% YTD and 84% since the start of September.
  • This substantial jump matters for UK consumers and businesses given its importance as a source of power. EDF estimate that 78% of buildings are heated with gas. In the US by comparison it is just 50%. In terms of electricity generation, in 2020 35% came from gas, ahead of wind at 24% and nuclear at 14%. The impact on consumers is clear for all to see in Ofgem’s 12% and 13% hike to the energy price caps for default tariffs and pre-payment customers respectively, that took effect from last Friday. A further, potentially substantial, rise is likely when Ofgem reviews the cap again in February. Clearly this will have consequences for inflation with gas and electricity prices making up 3% of the CPI Basket. Deutsche Bank estimate that it could add 50-60bp to headline CPI. And household spending and industrial activity could also be impacted (fertiliser production being a recent example), so yet another headwind for an economy that is already showing signs of slowing.
  • Why have prices risen so much? A smorgasbord of factors have been at play. After a cold winter and spring, supplies have not been replenished as much as expected. The UK has the added problem compared to many other major European economies of having very little storage capacity, just 2% of its annual demand. Consequently, the country relies more on pipeline and LNG imports, with the UK importing more than half its gas (75% from Norway and Qatar). With competition for LNG supplies high due to elevated levels of demand in Asia, alongside restrictions to US LNG supply and the overall lack of LNG terminals and shipping, it is hardly a surprise that prices have surged. Pipeline flows from Norway, the biggest source of gas imports (55% of total in 2020), have also been under pressure due to higher levels of gas field maintenance this year and increased domestic demand due to water shortages for hydro. Nature hasn’t been helpful in the UK either with a lack of wind limiting the use of wind power.
  • How long will this surge in prices last? Some of the factors should be transitory; the wind will blow soon (!) and some shorter-term supply issues are likely to be resolved. However, key further out will be how long the surge in Asian demand continues and what sort of winter we experience. And while inventories remain depleted, prices could well remain elevated until well into next year. That’s certainly what futures are telling us in the UK with prices not dropping from current levels until the spring and then remaining well above pre-pandemic levels thereafter. This has obvious negative consequences for the growth/inflation outlook.

Key economic data in the week ahead

  • Employment data from the US will be the most scrutinised release of the week as the Fed has said the recovery in the labour market is key to its path towards tightening policy. Progress in Washington on the fiscal front and around the debt ceiling will be closely monitored. OPEC+ meets on Monday to review its output policy against the backdrop of an oil price that has recently risen above $80bbl for the first time since 2018.
  • In the US September’s ISM Service Index is released on Tuesday and although expected to remain strong at 59.9 this would be lower than August’s reading of 61.7. Before Non-Farm Payrolls, the ADP Employment Change published on Wednesday is estimated to show a 430k increase, higher than August’s 374k and the YTD average of 418k. Initial Jobless Claims unexpectedly rose for the third week in a row last week to 362k. Thursday’s reading is estimated to see a small decline to 350k. Friday’s September Non-Farm Payrolls are forecast to add 470k new jobs, an improvement on last month’s disappointing 235k. The unemployment rate is forecast to fall to 5.1% from 5.2% in August.
  • Although there will be no significant economic data released from the UK this week, the Chancellor of the Exchequer will speak at the Conservative Party conference on Monday and is expected to announce a package of grants to help households facing a cost-of-living crunch.
  • Retail sales in the EZ on Wednesday are forecast to have increased 0.9%mom in August following the 2.3%mom fall in July. This would leave it up 0.4%yoy, which would be the lowest rate of growth since March when the continent was emerging from stringent lockdown measures.
  • It is the Golden Week holiday in China. The Caixin Services Index for September is expected on Friday to show the sector still in contraction but improving to 49.2 from 46.7 in August.

Nothing of note from Japan this week.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

David Purcell

5th October 2021

Team No Comments

Getting ahead of COP26 and what it means for investors

Please see the below article from JP Morgan received this morning:

Companies that can get ahead of impending climate-change initiatives and work with governments to achieve their goals may benefit from first-mover advantage.

This November sees the UK play host to COP26 – the 26th Conference of Parties – where global leaders from almost 200 nations will come together and discuss climate objectives and, more importantly, revisit the commitments made as part of the 2015 Paris Agreement. The parties are likely to agree that efforts will need to be meaningfully increased to ensure that achieving net zero by 2050 is within reach. In the coming years, investors can expect a raft of policy changes, with governments increasingly targeting public spending on infrastructure. Corporates are likely to face higher costs as a result of broader adoption of carbon pricing systems, but may find that capital markets reward them for focusing future investment spending on climate-related projects. Companies that can get ahead of the impending change and work with governments to achieve their goals may benefit from first-mover advantage. We discuss the technology and policy developments required to reach net zero in more detail in our paper, “Achieving net zero: The path to a carbon neutral world.”

More ambition required on the path to net zero

The main aims of the Paris Agreement were to keep global temperatures from warming above 1.5 degrees Celsius and effectively reach net zero greenhouse gas emissions by 2050. Countries were asked to submit their own emission reduction targets in the form of NDCs (Nationally Determined Contributions) and review them every five years. Importantly, COP26 is the first meeting of global leaders since the end of the first five year period. We now know that the proposals set out in 2015 are not sufficient to meet the target of restricting global warming to 1.5 degrees.

Just over 110 parties – accounting for around half of global emissions – have submitted new NDCs, but the United Nations (UN) has judged that these proposals still fall well short of the degree of change required to meet the 1.5 degree target. The UN estimates that current national plans will lead global emissions in 2030 to be around 16% above 2010 levels. In order to be consistent with the 1.5 degree target, 2030 emissions need to be below 2010 levels by 45%. With progress wide of the mark, the current proposals and potential improvements are expected to form a significant part of discussions at COP26.

The US, UK and European Union are all among those to have submitted new plans to reach net zero by 2050. The US has pledged to cut net carbon emissions in half by 2030 (relative to emissions in 2005), while the EU plans to reduce its emissions by 55% by 2030, relative to 1990. The UK has one of the most ambitious plans, aiming to cut emissions by 68% by 2030 (relative to emissions in 1990), but is responsible for less than 1% of total global greenhouse gas emissions. In fact, these three developed nations make up just 25% of global carbon emissions, which only makes clearer the need for global coordination.

Herein lies the challenge at this conference. A significant number of countries have still not submitted an update of their emission reduction targets. COP26 can only be deemed a success if all countries – including those with the highest emissions – decide to increase ambitions when they update their targets for the next decade. China has not updated its NDC but has stated its intention to reach peak carbon emissions by 2030 and net zero by 2060 – a pledge that does not go far enough for a country that is responsible for the largest amount of global carbon emissions. Undoubtedly, China will argue that the onus should be placed on developed countries, which initiated the industrial revolution, have a longer history of emissions and have the financial means to cut down on them (Exhibit 1). With China’s attendance at COP26 still in doubt, the potential for climate disputes to catalyse geopolitical tensions is increasingly clear.

Exhibit 1: US and China CO2 emissions over time

The metrics used to measure emissions make a huge difference: on a per capita basis, the US has a greater level of emissions than China (Exhibit 2). It is also worth noting that around 14% of China’s carbon emissions are attributable to goods that are exported and consumed abroad, which underlines the major role that recipients of China’s exports have to play in helping China to reduce its emissions. Another key expectation from COP26 will be for developed countries to make good on their promise to deliver at least USD 100 billion in finance per year to support developing countries in their climate goals. OECD data suggests that around USD 80 billion was mobilised in 2018. Commitments to increase this support will perhaps encourage some of the important developing nations to step up their carbon-reduction initiatives.

Exhibit 2: Global CO2 emissions per capita

Considerations for investors

Investors should be prepared for climate-related headlines in the coming weeks, as COP26 acts as a catalyst for governments and corporates to make new, more ambitious commitments. We expect this to impact financial markets in multiple ways.

Green bond issuance set to grow

Green infrastructure spending will be a major focus for governments that are under pressure to demonstrate their climate credentials to an increasingly green electorate. There are already several examples. The Biden administration’s USD 2.3 trillion American Jobs Plan includes multiple spending measures aimed at clean energy technology and the transition to electric vehicles. It is a similar story across the Atlantic, with the UK government’s Ten Point Plan for a Green Industrial Revolution aiming to generate 250,000 green jobs. In Europe, at least 30% of spending in the EU’s EUR 750 billion recovery fund must have climate-related benefits. Yet with more than USD 13 trillion of global investment in electricity systems alone estimated to be required by 2050 if net zero targets are to be reached, the scale of the challenge is clear.

A rise in green bond issuance will be the key means by which governments will fund new climate-focused spending. The European Investment Bank became the first issuer of green bonds – for which proceeds are earmarked for environmentally friendly outcomes – back in 2007, and both governments and corporates have flocked to the sustainable bond market since, with green, social and sustainable bond issuance growing from just USD 6 billion in 2012 to over USD 700 billion last year. The popularity of the market is unsurprising given that strong demand for this debt often leads to lower borrowing costs for the issuer – a dynamic known as the green premium, or “greenium” (Exhibit 3). Despite this benefit, the US government remains a notable absentee from the green bond market. While officials have so far been reluctant to discuss this idea publicly, the emergence of a “Green Treasury” appears increasingly inevitable.

Exhibit 3a: Global sustainable, social and green bond issuance

Exhibit 3b: Spread between green and traditional corporate bonds

Private capital encouraged to be part of the solution

An acceleration in government spending is one piece of the puzzle, but we also expect to see further measures aimed at incentivising private capital to be part of the solution. Strengthened regulation that pressures large investors to tilt portfolios towards climate-friendly strategies is one way to achieve this outcome. Another route is for governments to co-invest alongside the private sector in public-private partnership models. This type of structure can often be used to ensure that initiatives that would be too risky for the private sector to invest in alone can still access the financing they require.

Corporate announcements to demonstrate the leaders and laggards

In the face of increasing investor scrutiny, the corporate sector is unlikely to wait for regulation to force its hand on tackling climate change. The number of companies signing up to science-based target commitments had already surpassed last year’s record by June of this year, and November’s summit will intensify pressure on corporations that are not yet on board. Those that are able to align with government goals will benefit from government spending and be rewarded with access to easier finance through capital markets. Central banks are likely to incorporate green bonds or tilt their corporate asset purchases towards companies that are making investments consistent with net zero, meaning these companies will likely benefit from relatively lower borrowing costs. Additionally, investors may find comfort in owning the bonds of these firms, particularly in more stressful market environments, in the knowledge that the central bank is likely to be a willing buyer.

In industries such as energy, logistics, airlines and farming that are typically carbon intensive, there are also reasons to be optimistic. Those that adopt policies that help reach net zero will likely gain market share and be viewed as part of the solution, rather than the problem. Whatever the industry under consideration, investors may find opportunities by identifying companies that are better prepared for the transition.

Carbon pricing likely to impact corporate profits

Reaching agreement on a global carbon pricing system will be one of the most challenging issues of the summit. We cover how such a system could work in our paper, “The implications of carbon pricing initiatives for investors.” While some regions, such as Europe, have already made substantial progress, firms will remain incentivised to outsource production to other regions with lower carbon costs until a global solution is reached. Without a global solution, regions that decide to go it alone also risk imposing a competitive disadvantage on the profit margins of their domestic corporations. The risk of disagreements on carbon pricing spilling over into broader international relations is clear, with Europe perhaps needing to introduce a carbon border tax if other countries decide not to adopt a carbon pricing system. Without substantial progress, the path to net zero looks worryingly steep.

Conclusion

Investors should be braced for a wave of new climate ambitions stemming from November’s COP26 summit. With the conference serving to shine a spotlight on the enormous challenge presented by the need to reach net zero by 2050, both the public and private sectors will be keen to stress the extent of their ambitions, with potentially market-moving implications. For investors, there are risks and opportunities across sectors. Companies that prove they can be a part of the solution will likely benefit from a lower cost of financing in the years to come, as both governments and the private sector look to tilt their spending towards green initiatives. For businesses that are poorly prepared for the climate transition – regardless of sector – life will only get tougher.

Keep checking back for more of our regular blog content including market insights and views from some of the world’s top investment managers.

Andrew Lloyd DipPFS

4th October 2021