Published: December 07, 2021

Relevant Strategies

• International Balanced
• International Growth
• Natural Resources
• Gold and Precious Metals
• Peter Schiff

Our Commentary

Market overview

In a month which saw the emergence of a new acronym: VFI (Variants, Federal Reserve and Inflation), stock markets were volatile, achieving new highs early in the month before being knocked back by US inflation coming in at a 31-year high, and then slumping as news of the new Covid-19 Omicron variant emerged. The S&P 500 Index slipped marginally into the red, while the Dow Jones Industrial Average and Nikkei 225 fell 4%. The UK FTSE 100 Index and the Euro Stoxx 50 both declined a little over 2%. All developed equity markets remain in the black for the year to date, though, while most bond markets are weaker.

Equity markets remain underpinned by corporate earnings growth, with Macy’s, Kohl’s and Nvidia the most notable advances after posting market-beating numbers. Overall, growth indicators remain positive.

Meanwhile, energy concerns abated as President Biden indicated that the US may release more reserves, and pressure built on OPEC to add supply to the market. The retracement in prices accelerated as news of the Omicron variant became public and countries began shutting their borders.

Fed timetable for tapering asset purchases

The main policy development came with the Federal Reserve announcing it would begin tapering its asset purchases with a view to completing the process by June next year.

The chart below indicates the pace of tapering as anticipated at the meeting in early November, although subsequent comments indicated this may be accelerated. Equities and bonds responded positively but then became concerned about whether persistently high inflation would prompt the central bank to start raising interest rates more aggressively than their guidance suggested. There is a danger that, with demand still buoyant, supply issues exacerbated by new restrictions to prevent the spread of the new Covid-19 variant will further fuel rises in inflation.

Carbon credit markets in focus after COP26

The UK hosted the 26th UN Climate Change Conference (COP26) in early November and this gave new life to the carbon credit market with a number of agreements made on the rules that govern it.

Background

The carbon credit market has its roots in the 1997 UN Kyoto Protocol, the first time the world’s governments agreed on the need to cut carbon emissions. Called the Clean Development Mechanism, it facilitated the reduction of industry and country emissions through the trading of carbon credits. Today, there are two markets: the voluntary exchange of carbon credits and the involuntary carbon compliance market.

The former allows companies and individuals to buy carbon credits to compensate for their carbon emitting activities. These credits are then invested into carbon-catching activities aimed at reducing the level of emissions by planting forests and other activities. The global standard is that one carbon credit represents one ton of carbon dioxide equivalent (CO2e) removed from the atmosphere.

How it works

The carbon compliance market is otherwise known as the cap-and-trade market. Governments set caps on the amount of CO2e companies in high-emitting sectors (e.g., oil, energy, transportation) are allowed to emit before they are required to buy carbon credits. The intention behind this is to help companies make a gradual transition to a sustainable, carbon-free future, avoiding the disruption and cost (to company and economy) that overnight change would cause. Emitting companies have time to transition their business, while the projects in which the carbon credits are invested balance the equation, capturing carbon and neutralizing the emissions impact of the company buying the credits.

When companies reach their cap, they can buy and sell carbon credits on regulated exchanges. According to the World Bank, there are around 64 carbon compliance markets currently in operation, the largest of which are in the EU, China, Australia and Canada. The US has no overarching federal approach to requiring companies to comply by reducing emissions. Instead, states have been free to take an independent approach, with California the only one with a formal cap-and-trade market.

Strengths and weaknesses

The current cap-and-trade system is vulnerable to fraud, double counting and greenwashing. In the early days of the carbon credit market, white collar criminals took advantage of tax loopholes by fraudulently claiming VAT receipts through complex arrangements of companies in different jurisdictions.

More recently, companies have been found double counting the carbon credit, once in the country in which they operate and again in the country where the credit is bought. There is little oversight of projects that are supposedly reducing emissions. For instance, some tree planting projects have been found to cut down the trees after gaining the credit.

To reduce the likelihood of nefarious schemes, regulators are eager to globalize the carbon credit market. However, there are challenges in agreeing parameters such as time frame, pricing, measurement and degree of transparency.

Opportunities

Notwithstanding the challenges, the future for the carbon credit market looks bright. According to a September report by Ecosystem Marketplace, in the first eight months of 2021, voluntary carbon markets had already posted a near-60% increase in value from last year to more than $1 billion. With market volumes and value rising strongly, more speculators are purchasing credits. This then becomes a source of finance for green projects around the world. A tightening of processes and rules at COP26 could open the door to billions of dollars of investment over the next decade.

A recent Visual Capitalist infographic highlights the potential 15-fold growth in carbon offsets by 2030:

Outlook

VFI (Variants, Federal Reserve and Inflation) will continue to have influence over market sentiment and price action in the medium term as they have always been since the beginning of this year.

In the medium term, we think the equity market will remain buoyant with the support of solid corporate earnings growth and the likelihood of a strong shopping season in December despite supply chain shortage remains a concern.

The carbon compliance market, which is projected to grow to 50 billion dollar by 2030, is a lucrative investible opportunity that needs attention from savvy investors. We will explore this topic further in future commentaries.

The portfolios’ November performance is as followed:

Regards,

Euro Pacific Advisors Management Team

Published: November 09, 2021

Relevant Strategies

• International Balanced
• International Growth
• Natural Resources
• Gold and Precious Metals
• Peter Schiff

Our Commentary

Market overview

Most equity markets rebounded in October despite a multitude of concerns. Quantitative easing is still going at a pace unimaginable a few years ago and trillions of dollars of new stimulus measures look set to pour fuel onto an inflationary fire running at an annualised 5.4% in the USA. Supply chains are squeezed as never before in peacetime and wages are rising rapidly, probably far faster than the official figures.

And yet, the S&P 500 is at an all-time high, a third higher than it was before the pandemic. Many believe the S&P 500 is expensive – despite a good third quarter earnings season. The US bond market is, arguably, also expensive (although cheaper than it was) because there are mounting expectations that the Federal Reserve will begin raising interest rates sooner rather than later despite continuing to forecast that the pick up in inflation is transient. Global benchmark US Treasury bond yields increased to 1.6% and the US Federal Reserve is still expected to begin its tapering program in November.

UK gilts signaling sharp rate hikes

Following September Monetary Policy Committee meeting’s narrative, The Bank of England appears decidedly more hawkish. Governor Andrew Bailey has warned that interest rates must soon rise to stem inflation currently running at 3.1%. However, there is clearly a political desire for wages to rise as part of a “high wage, high growth economy”.

The London money markets are pricing in a rate hike to 0.25%, from 0.1%, at the Bank’s next meeting on November 4th, and the price movement in gilts reflects expectations of a further move to 1% by May. This seems like an overreaction, but may reflect the fear that the Bank of England is on the brink of a policy error.

Assuming the Bank of England does raise interest rates to 0.25% this week, does the market really believe that it won’t wait to see the impact on the consumer in the run up to Christmas as well as the effect on the housing market?

The Bank of England’s message also throws up another problem which goes against current market expectations. The conventional wisdom was that, long before there was ‘talk about talking about’ interest rate hikes, quantitative easing stimulus would be wound down. At the very least, the market expected a timetable for stimulus easing.

U.S corporate earnings growth remains resilient

Valuations in developed world stock markets remain extended but market analysts are generally confident that equities will continue to gain ground on strong earnings performance.

Financial companies was the first sector to announce third quarter earnings. Prospects for the sector are viewed favorably — alongside energy — with commodity prices, particularly oil and gas prices, having gained considerable ground in recent weeks on worrying shortages.

The vast majority of S&P 500 companies that have so far reported have exceeded profit expectations with 88% of financial companies beating forecasts by a wide 21% margin.

Supply shortages and slowing growth dampen optimism

Europeans are bracing themselves for a cold winter based on gas shortages and sky-high prices. In the UK, panic buying of fuel by drivers has resulted in price increases and China has had to contend with a significant shortage of coal, which has necessitated energy rationing in the industrial sector and some residential blackouts.

Supply shortages and delays continue to dog the transport of goods to where they are needed, affecting sectors such as electronics, autos, meat, medicines, and household products. Several US companies have warned of rising costs due to supply chain disruptions, admitting these could have an impact on earnings. Companies that have been least affected include those that have wide product margins and pricing power, including tech and healthcare companies.

The supply constraints stem from a mix of transport restrictions related to the pandemic but also under investment in transport infrastructure and electronics production and a reluctance of workers to return to high-risk Covid-19 sectors.

An emerging concern has been evidence of a slowdown in growth in some of the developed markets production come in much weaker than the market was expecting. This was attributed to hefty declines in the mining and utilities sectors due to one-off weather-related factors.

China’s GDP also came in well below expectations and it is likely to remain under pressure given its energy challenges. The world’s second biggest economy has also seen a rise in Covid infections. These factors may dampen economic activities should they continue.

Inflation revisited

A lack of shipping containers, port closures and delays, a shortage of truck drivers, lack of computer chip production capacity, electricity shortages in China and India, and rising global commodity prices are all likely to contribute to global inflation rising by 1.5 percentage points in Q3 2021, according to OECD estimates.

Euromonitor forecasts global inflation to reach 4% in 2021 before falling back to 3.6% in 2022. In our opinion, a positive year for equity and bond markets in 2022 depends on any further increase being limited.

Outlook

UK rate hikes

Raising the prospect of hiking interest rates before any discussion of the Bank of England’s plans for quantitative easing sends a confusing message to markets. Is inflation temporary? Would higher interest rates be temporary? We all know that the Bank of England can, if it wants, afford to be nimbler than her US cousin, whose policy turns like a fully laden oil tanker. Is this part of their thinking? If it is, then the bond market may have got it wrong in pricing for aggressive UK rate hikes.

Slowing economic growth

Euromonitor research shows that Covid-19 remains the primary economic concern going forward. It ascribes a 28% probability to a pessimistic Covid-19 scenario in which more infectious and vaccine-resistant variants result in multiple economic lockdowns in 2022.

It also points out that global economic growth has deteriorated since mid-2021. Euromonitor expects global real GDP to increase by 5.7% in 2021 (a 0.2 percentage point downgrade since July) and has significantly downgraded 2021 growth expectations for US, China, Asia Pacific economies, although its expectations for the Eurozone are up.

The portfolios’ October performance is as followed:

Regards,

Euro Pacific Advisors Management Team

Published: October 11, 2021

Relevant Strategies

• International Balanced
• International Growth
• Natural Resources
• Gold and Precious Metals
• Peter Schiff

Our Commentary

Market overview

September witnessed the reversal of third quarter’s gains as turbulent equity and bond markets suffered declines due to a broad range of factors:

• Concerns about global growth waning due to the highly infectious Delta Covid variant
• Broadening and deepening supply bottlenecks
• Rising inflation and hastening interest rate rises
• Numerous negative developments in China seen as posing downside risks to financial markets

Evidently, the Citi Economic Surprise Index, shown below, highlights the extent to which negative economic surprises are now exceeding positive surprises.

For the month, the S&P 500 Index declined by 4.9% and the NASDAQ by 5.3%, while the FTSE all-share Index retreated by 1.1% and the Eurostoxx 50 by 4.7%.

In the U.S., sector rotations continue to play a large part in investor strategy. According to our observation, nearly 90% of S&P 500 constituents have experienced at least a 10% correction during the year but the index has not drawn down by more than 5% at any point.

Contrastively, pockets of emerging markets performed better, such as the MSCI India index which registered a 2.0% gain. Nevertheless, all major stock markets remain in positive territory year-to-date except for China’s CSI 300 Index, which has declined almost 7%.

Elevating pressures from Central Banks

This year, investors have been focused on the impact of the looming debt ceiling deadline and the US Federal Reserve’s tapering intentions. For a brief period, the prospect of a government shutdown and the worst-case scenario of a sovereign debt default and downgrade suggested that the Fed may have to move out its tapering timeline. However, the U.S. Senate eventually announced a deal which avoided shutting down on October 1st and extended government spending until December 3rd of 2021.

Meanwhile, tapering looks set to begin based on the Federal Open Market Committee’s (FOMC) post-meeting comments in late September. The committee judges that a moderation in the pace of asset purchases may soon be warranted and Chairman Jerome Powell opined that “a gradual tapering process that concludes around the middle of next year is likely to be appropriate.”

Another major concerns by investors is rising interest rate. The majority of FOMC members see the first US interest rate hike happening in 2022, a shift from June’s meeting when the majority expected it in 2023. As a result, the 10-year US Treasury yield has bounced off its lows and is trading at about 1.5% — a level investors were expecting only later this year.

Across the Atlantic, the minutes from the Bank of England’s September Monetary Policy Committee meeting also highlight increasing concern about the durability of inflation. Some commentators now expect two interest rate rises next year with the first coming as early as the spring.

UK gilts have reacted to the changes in interest rate expectations even more strongly than US treasuries with a 50 basis points increase in 10-year yield since mid-August. This trend may has further to run as inflation continues to surpass the Bank of England’s expectations. It now forecasts consumer price inflation to peak above 4% at the turn of the year (well-ahead of the 2.1% forecast it issued in February) and not to fall back to its 2% target until the second half of 2023.

China sentiment further deteriorates

Evergrande crisis

In addition to slowing Chinese economic growth and government crackdown on the tech sector and online education industry as discussed on a past commentary, the news that Chinese property giant Evergrande was facing a debt crisis derailed market sentiment further. The property developer amassed mountains of debt, predominantly domestically, when it expanded from housing into a range of other ambitious initiatives including electric vehicles, sports, and theme parks.

The crisis came to a head in late September when Evergrande failed to meet a debt payment. It has 30 days to settle and avoid triggering a formal debt default. Investors are on edge, waiting to see whether the government will back the debt, whether it will be rescheduled or whether the company will default and become akin to a “Chinese Lehman Brothers.” In dealing with this issue, the Chinese government is not expected to bail out the company, but it has been adding liquidity to financial markets to avert broader contagion.

Implications

Evergrande’s situation has broader ramifications for China and, to an extent, global economy because the Chinese property sector contributes almost a third to Chinese GDP. As a result, a slowdown in the Chinese economy would not bode well for the rest of the world, which has relied on the vibrant recovery in China to provide tailwinds for their own economies.

We can perhaps gain some comfort from the commitment of the Chinese government to reducing speculative activities in the economy and implementing regulations to prevent excesses from building up. The intention is to introduce more balance into the Chinese economy and promote “common prosperity”. The success will depend on whether the regulators can steer the private and public sector without too many missteps.

Despite sentiment in Chinese markets is currently weak and government policy is putting the brakes on growth, the year’s final quarter is historically strong for Chinese equities with prices moving up on average by 3.6% in October alone.

Portfolio Actions

Our Chinese equity exposure is balanced between infrastructure and technology sectors which, notwithstanding recent interventions, offer huge growth prospects at relatively low valuations. Furthermore, we have no direct exposure to Evergrande so concerns over the company’s default risk is very low on our table. From both a short and longer term perspective, we think it is not the time to withdraw from investing in the world’s second largest economy.

On the other hand, with interest rate hikes and the FED’s tapering coming possibly later this year or next year, our International Balanced and International Growth fund are well-diversified to withstand any potential short-term market volatility. Tactically, we are also holding less than 10% of our funds’ weight in cash to take advantage of any potential market’s pullback.

The portfolios’ September performance is as followed:

Regards,

Euro Pacific Advisors Management Team

Published: September 08, 2021

Relevant Strategies

• International Balanced
• International Growth
• Natural Resources
• Gold and Precious Metals
• Peter Schiff

Our Commentary

Market overview

August saw stock markets continuing to march higher to a record-beating earnings season, despite the far-reaching spread of the Delta variant raising concerns that global growth may have reached its peak, and we could fall back from here.

In the U.S., the Dow Jones Industrial Average advanced 1.5% while the S&P 500 was up 2.6% and the Nasdaq lead the way by gaining 3.1% for the month. The S&P 500’s forward P/E, which captured investor expectations 12 months down the line, remained elevated at 20.9, indicating that investors continued to anticipate strong earnings growth.

Across the Atlantic, the FTSE 100 and the Euro Stoxx 50 experienced similar increases of 1.7% and 2.5% respectively. In the Pacific region, China’s CSI 300 Index managed to eke out a 0.4% gain during the month notwithstanding the regulatory clampdown, that sent its technology and online education stocks spiraling lower in the previous months. For the year, it is one of the few stock markets that is still in the red, down by almost 8% year-to-date.

State Street is less confident than Wall Street

While US stock market indices marched higher in August, U.S. consumer confidence took a big knock in the same period.

A cause for concern is that zero-COVID economies such as China, Singapore, Taiwan, Australia, and New Zealand, which have tried to completely stamp out the virus, have seen a renewed rise in infections. This event has undermined many investors’ confidence that the virus will ever be completely vanquished.

A growing pool of expert opinion suggests that COVID is likely to become endemic, much like the seasonal flu, and that we will have to learn to live with it.

Fizzling momentum, waning mood

The impact of the Delta variant started to be felt during October of last year, with the rollover of the purchasing managers’ index (PMI) and Citibank’s Global Economic Surprises Index, which reflected whether economic activities were outperforming or underperforming forecasts. To note, the Global Economic Surprises Index has turned negative for the first time since mid-2020. This indicator highlighted waning investors’ mood due to the US and international data releases were missing forecasts at a noticeable rate.

Whether this news has any impacts on future markets returns is unknown, studies has shown that 1% surprise in quarterly GDP growth is associated with 0.7% change in quarterly U.S. equity returns in the last 30 years.

On the other hand, recent PMI data released by the National Bureau of Statistics also showed that China, where outbreaks of the virus have been strictly managed, has experienced economic activity slowdown. The country’s service sector PMI data has also fallen below 50 for the first time since the first quarter of last year, signaling a contraction. Its manufacturing sector and export orders declined in tandem.

US Government debt revisited

Relationship between yield and sentiment

Yield changes highlighted the sensitivity of rates to prevalent investor sentiment. In the first quarter of this year, yields rose on inflation fears. In the second quarter, they fell on concerns of slowing growth. Two months on and investors are still harboring concerns about growth and investors still seem appeased by Powell’s commitment to address inflation as and when needed.

A hot summer for US Treasuries

The perplexing decline in US bond yields continued into August, with the US 10-year Treasury yield remaining below 1.4%, having traded at 1.75% at the end of March. During August, the world’s benchmark interest rate started out at 1.17%, reaching a high of 1.367% around mid-month before ending August below 1.3% again.

The dip in yields was attributed to concerns about slowing growth and uncertainty about whether the US Federal Reserve will begin tapering off its bond buying programs by the year’s end or next year. At the much-anticipated Jackson Hole Symposium towards the end of the month, FED Chair Jerome Powell managed to keep investor sentiment on an even keel by acknowledging that tapering may begin later this year but that it would be conducted cautiously and carefully.

US equity investors took the news in their stride with stock market indices again reaching new highs by the end of the week, while the US Treasury Yield ticked up from its mid-month lows. Expectations of the 10-year treasury yield reaching 2% by year-end were no longer commonplace, although some market commentators thought that it was still possible. According to FactSet data which showed the average forecasts of analysts last month, the 10-year yield was expected to rise to 1.8% by the year-end from 1.31 %. However, Goldman Sachs and JP Morgan have both cut their 10-year yield forecasts to 1.6% and 1.75% by the end of 2021. Citigroup, in contrast, still expected the yield to come in at 2% for the same period.

Portfolio Actions

Despite the fall in yields, there are widespread expectations that inflation is not going away quickly. With investors’ sentiment and PMI reading on a declining trend into August, whether the current stock markets’ growth momentum can be maintained remains a question mark.

Additionally, a market discrepancy that we have noticed is despite improving labor markets booming US economy, interest rates at present levels are not compatible to the current market conditions. What is even more important for investors is the inflection point, in which interest rates are raised to match with the corresponding economic conditions. This event can potentially bring intense volatility to both equity and bond investors’ portfolios. Regardless of the outcomes, our portfolios remain diversified to prepare for such market events.

The portfolios’ August performance is as followed:

Regards,

Euro Pacific Advisors Management Team

Published: August 06, 2021

Relevant Strategies

• International Balanced
• International Growth
• Natural Resources
• Gold and Precious Metals
• Peter Schiff

Our Commentary

Financial markets buffeted by cross currents

July witnessed a variety of cross currents at play in the financial markets. They are the following:

• The spread of the more highly contagious Delta Variant and potential economic impact due to measures that may be needed to prevent its further spread.
• Worries that the global economy may have reached peak economic performance which may lead to plateau or slip from now.
• The ongoing debate about inflation, with more support for it likely to be transitory than turning into 1970’s high inflation.
• Supply shortages, which saw the prices of commodities and other items rise as demand continued to outpace supply and delivery of goods remained slow.
• Tense US-China relation, which was viewed as likely to translate into even further decoupling with huge ramifications for the global economy.
• China causing havoc in the tech sector and broader stock markets by coming down hard on promising Chinese tech companies due to what it defines as data privacy issues.

Surprisingly, investors seem to shrug off these concerns and the US stock market made further progress with the broad-based S&P 500 rising 2.4% during July, ahead of the Dow Jones Industrial Average’s 1.3% gain.

Across the Atlantic Ocean, the main European and UK indices saw little changes but like all the major US indices have provided double-digit gains year-to-date. Meanwhile, Japan’s Nikkei slipped 5%, reducing the index’s year-to-date gains to 0.2%.

Delta Variant and the global economy

In the UK, the nervously anticipated Freedom Day on 19 July went ahead despite the rise in delta variant-related infections. Prime Minister Boris Johnson defined the opening as a move away from legal restrictions to personal responsibility.

So far, the reopening has had a favorable, but relatively muted, impact on the economy, with less movement and activity than expected – probably a result of cautious attitudes as a result of the rise in infections. Towards the end of July infections began to ease off, which bodes well for the world’s economy to shift towards more normal activities.

With the COVID-resurgence-fear simmered in the background, the latest World Economic Outlook, released by the IMF, has highlighted the still growing divergence between advanced and emerging market economies with the latter expected to outperform until 2022.

At a global scale, the IMF projection maintained its forecast 6% growth rate for the world, while upping the rate of growth expected from advanced economies and reducing it for emerging markets, particularly emerging Asia. The change seemed to be influenced by rates of vaccinations as having a big impact on the different macro-economic experiences across the world.

In the US, GDP growth came in at 6.5% for the second quarter – two percentage points lower than economists’ projections but seen as a solid performance for the world’s largest economy. The shortfall was ascribed to the clogged supply chains that are slowing down inventory rebuilding as we are seeing one of the lowest Global PMI Suppliers’ Delivery Times Index reading in 21 years.

As an indication of the buoyant demand that is resulting in supply constraints, consumer spending soared for the second quarter, with spending on goods up 11.6% and services, including restaurants and airfares, 12% higher.

On the other hand, spending levels are being underpinned by the trillions of federal rescue money that has been introduced into the US economy.

Chinese stock market woes

The CSI300 Index continued to suffer from the surprising clampdown on technology companies, with the Chinese government citing data privacy concerns. Sentiment was also hit by the announcement of a complete regulatory overview of the $100 billion online education industry, one of the favorite sectors among foreign investors.

As a result, Tencent saw its share price sell off by 9% in its worst day in a decade, erasing $100 billion from the company’s market capitalization. Other notable company hurt in the sell-off was Meituan, a food delivery firm, which lost 18% in one day. Alibaba and JD’s stock price were no exception to the market trend either.

The Chinese government has also announced that she is exploring various measures to contain the rapid expansion in these technology companies, including anti-monopoly investigations, new laws, and direct communications with top executives. While these measures and what they entails are unknown, the uncertainty it creates will keep investors away from the market in the short-term.

Outlook

Despite fears of a new wave caused by the highly infectious COVID-19 Delta Variant, we foresee the global economies continue its track to recovery with growth divergence skewing towards the emerging markets in the next year.

While Chinese stocks experienced a beat down in the last months, the Chinese government’s surprising and far-reaching shifts in market regulation has highlighted that they were more concerned about managing the capital markets than scaring off foreign investors.

Historically, the Chinese tech sector has suffered from sharp reversals in the past and it has recovered strongly. Furthermore, their valuations are no higher than those of US counterparts despite growth trends and prospects remaining stronger while anticipation of monetary easing in China is growing. This is supportive of equities in the long-term.

Portfolio Actions

We want to maintain our portfolio’s current composition but be very responsive to critical changes in the market. Hence, we are tactically holding less than 10% of the portfolios’ weight in cash while refraining from adding new investment ideas to the portfolios.

The portfolios’ July performance is as followed:

Regards,

Euro Pacific Advisors Management Team