Euro Pacific Bank

Portfolio Commentary: Markets Volatile but China Stimulus Lifts Mood

Published: June 16, 2022

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Relevant Strategies

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

Our Commentary

Market overview

It was an exceptionally volatile month for stock markets with the main developed market indices losing substantial ground before experiencing a bear market rally in the closing days of May. A trifecta of factors was behind this turbulence: hawkish central banks, the ongoing impact of the Ukraine-Russia war on the macro economy and a slowdown in China as a result of its zero-Covid policy.

The 5% bounce-back in the S&P 500 in the final four trading days of the month saw the broad-based index end the month flat but still 13% lower for the year to date. The NASDAQ didn’t manage to get into positive territory and remained a hefty 22% in the red after its rout over the past six months.

Most European equity markets also remain in the red year-to-date but not to the extent of long-dated bonds, which have fallen in value by around 20% since the start of the year (and in some cases by more). Commodities remain strong with the broad-based Bloomberg index up by 33% this year.

The end of month fillip saw US stocks end their longest losing streak in two decades:

Longest losing streak for US stocks since 2001 comes to an end. Source: Bloomberg.

Bloomberg’s data also showed the S&P 500 Index daily trading range having exceeded one percent 89% of the time this year, the most sustained period of daily variations since 2008:

S&P 500 is off to its wildest start to a year since 2008. Source: Strategas Securities, LLC.

The range of performance across sectors was extreme, with energy stocks up almost 60%. The worst performing sectors—communication services and consumer discretionary stocks—have declined well over 20%:

S&P 500 energy stocks have surged ahead of other sectors in 2022. Source: Bloomberg.

Sentiment reversal for Chinese stocks?

Chinese stocks surprised by eking out a 0.3% gain during a month when the economic news was particularly dire. The CSI 300 Index remains 18.5% off for the year to date but a massive stimulus and an easing of Covid restrictions, alongside emerging signs that infection rates are declining, should provide positive tailwinds for Chines equities in the months to come.

Covid and lockdowns drive China into contraction for a second time. Source: China’s National Bureau of Statistics.

In late May, the government announced a 33-point stimulus package of almost 500 billion yuan that included 140 billion yuan ($21 billion) in additional tax rebates, emergency loans for the aviation sector and 300 billion yuan in railway construction bonds.

These measures are intended to provide a cushion for an economy suffering from the government’s stringent implementation of its zero-Covid policy.

China’s 2022 tax cuts to exceed 2020’s in attempt to cushion virus impact. Source: Chinese government work reports; China National Radio.

Technology shares starting to offer value?

Meanwhile in the US, technology stocks have taken a real beating this year but an increasing number of analysts are convinced that valuations have declined to the point where these stocks offer an attractive upside.

NASDAQ 100’s bear market at its low was the worst since the global financial crisis. Source: Bloomberg.

CEOs and investors who sat on a panel at Davos during the World Economic Forum pointed to the fact that even though there has been a $1 trillion sell down in technology stocks, good business models and strong revenue generation mean fundamentals are much more supportive than they were during the dotcom bubble. The industry is trading at close to its three-year average PE ratio of 29.0x and some of the tech giants are trading at cheaper valuations than traditional value stocks.

For example, Facebook parent Meta Platforms Inc.is trading at 14 times forward earnings, cheaper than prominent value stocks like Berkshire Hathaway Inc., Johnson & Johnson, UnitedHealth Group Inc. and Procter & Gamble Co.

Google parent Alphabet Inc. is also trading at a relatively low multiple. However, the prices of Amazon and Tesla are still based on a high multiple of current profits. Overall, Morningstar metrics suggest technology stocks are at their cheapest since March 2009 when markets were beginning to recover from the global financial crisis.

Google and Facebook are now cheaper than many value stocks. Source: Bloomberg.

Outlook

In the period of market stress, defensive assets such as investment grade credits and value stocks become more attractive. While the question of future growth and inflation remain unanswered, the most logical stand is to wait and see while maintain a comfortable allocation in liquid assets.

Our portfolios’ performance in May is as followed:

Fund Name Performance
International Balanced -1.58%
International Growth -2.05%
Natural Resources 3.66%
Gold & Precious Metals -8.77%

Regards,

Euro Pacific Advisors Management Team

Portfolio Commentary: Bond Market Tumbled amid Market Headwinds

Published: May 13, 2022

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Relevant Strategies

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

Our Commentary

Market overview

April was the month reality set in for investors that the myriad headwinds facing the global economy and financial markets are not about to alleviate any time soon and could magnify beyond current expectations.

Stock markets sold off sharply in a three-day rout in late April and ended the month deep in the red. The US S&P 500 and Nasdaq led global equity markets downwards, with the former shedding 8.7% and the latter 13.3% in April alone. For the year, the Nasdaq has lost more than 21.1% and the S&P 500 12.9%.

China was also hard hit, extending its losing run that was set in motion last year when the Chinese authorities clamped down on tech and online industries, imposing much harsher regulations on their business activities. This year the world’s second largest economy has been dogged by ongoing Covid flareups, with Shanghai under strict lockdown during April and growing fears that Beijing may be next in line.

Elsewhere, Covid is proving less disruptive because even though numbers are rising, deaths are not and countries such as the UK are learning to live with the virus in the absence of a new more virulent strain emerging.

Vaccine policy keeping Covid fears muted
Flare-ups less likely but disruptions remain a wild card. Example: UK. Source: FTSE Russell.

Learning to live with inflation

The last several commentaries have identified inflation as the main driver of market movements since last year. In May, the bond markets had one their worst months ever, with yields jumping higher on concerns that the central banks may become overzealous in their implementation of more restrictive monetary policy conditions via higher interest rates and quantitative tightening. In both the US and Europe, indices of bonds with maturity greater than 10 years have declined in value by over 15% YTD.

With inflation at forty-year highs, the US Federal Reserve is still on track to raise the federal funds rate by at least 50 basis points at its next meeting. Moving forward, there is a growing argument that the Fed will take into account the potential for monetary conditions to tighten for other reasons, and that inflation is close to peaking.

Global Outlook. Source: BlackRock.

BlackRock and FTSE Russell see the central banks as learning to live with inflation. Notwithstanding projections of a series of rate hikes this year, they believe the central banks are likely to maintain low real yields, cognisant of the risks of reversing their quantitative easing policy too sharply. Excessive tightening could destroy demand and lead to a rise in unemployment.

Despite the hawkish tone, central banks will be wary of raising rates too quickly.

QE affected risk assets and rates positively
Central banks are highly aware of the positive effects that QE has brought and equally aware of the risks of reversing the policy. Source: FTSE Russell.

Downgrading growth forecasts

The IMF, the World Trade Organization and private sector economists are still factoring in a material slowdown in the global economy this year, downgrading their growth forecasts to reflect inflation, hawkish central banks, the ongoing Ukraine-Russia war and extended supply constraints, with China still set on maintaining its zero-Covid strategy.

The IMF downgraded its economic growth forecasts across 143 countries that account for 86% of global GDP, with global economic growth now expected to come in at 3.6% in both 2022 and 2023 – 0.8 ppt and 0.2 ppt lower than the growth projected in January this year.

The WTO is even more pessimistic, expecting world GDP to increase by a mere 2.8% this year and to pick up to 3.2% next year. The Peterson Institute for International Economics (PIIE) predicts that global economic growth will come in at 3.3% in both 2022 and 2023.

Clearly, recession is still not a base-case scenario but Europe is perhaps the region most vulnerable to this downside scenario. Despite the sharp deterioration in investor sentiment of late and material downgrades in growth forecasts, the world economy is still expected to avoid recession this year.

GDP growth and forecasts look robust next year
Optimistic backdrop: Rate-hike expectations have been fueled. Source: FTSE Russell.

U.S. elections loom on the horizon

Ahead for the US are the mid-term elections in November, which will inevitably affect the mood of the electorate. The prevailing view is that Republicans could well take back both chambers of Congress, which could result in policy gridlock.
Although markets tend to take such outcomes in their stride, it may increase volatility as policy differences become more apparent.

Republicans taking control of the House and the Senate is likely to result in fewer tax changes, greater increases in defence spending, fewer green initiatives and some contentious negotiations around the debt ceiling. That compares with the status quo, namely a moderate increase in defense spending, further climate bills aimed at putting in place green incentives and an easier path to raising the debt limit. We will doubtless see greater focus on the implications as the time nears.

Outlook

For opportunity seekers, April’s market volatility may prove to be a good thing. After years of being overlooked by investors who were seduced by handsome equity gains, the bond market may become attractive again as the yield on the 10-year Treasury note rose above 2.9% this month, notching more than 25% in gains.

As we are approaching the tail end of this economic cycle, some investor camp thinks it is not too early to be prepared for recessions by shifting to traditional defensive strategies. On the other hand, optimistic investors who still believe that the current bull market still have some legs may find hidden gems in the tech market, which is still reeling from rate hikes news and inflation.

We are currently adopting the wait-and-see dynamic in May. Additionally, by maintaining a small percentage of portfolios’ weight in cash (less than 10%), we may be flexible if attractive investment opportunities emerge for short-term plays.

The portfolios’ April performance is as followed:

Fund Name Performance
International Balanced -5.59%
International Growth -6.15%
Natural Resources -2.61%
Gold & Precious Metals -7.59%

Regards,

Euro Pacific Advisors Management Team

Portfolio Commentary: Ukraine, Inflation Dominated Market Sentiment

Published: April 11, 2022

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Relevant Strategies

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

Our Commentary

Market overview

Although stock markets improved during March, most remain lower year-to-date with some European markets and global growth sectors registering double-digit percentage declines. The only major developed stock market to be in the black year-to-date is the FTSE 100 which is registering a 2.9% increase. In contrast, the UK mid-cap index is 9.4% lower and the MSCI Europe (Ex UK) index has declined by 7.8%, having been particularly affected by the war and the impact of reduced access to energy supplies.

Despite the increasingly confrontational political rhetoric into the new year, only a minority of investors really believed a Russian invasion of Ukraine was imminent and the shock move raised the specter of World War III, a worst-case scenario that is not yet out of the question. In recent days, stock markets have found new optimism in any signs that talks between the two countries may result in a ceasefire. News that Russia would “retreat” from armed conflict in Kyiv and focus on the eastern territories saw stock markets rally into the final days of the quarter.

Commodities soar

In response to the Ukraine crisis, commodity prices have soared, with oil reaching $130 a barrel and prompting predictions it could reach as high as $200. Natural gas also rose further as the world came to grips with just how dependent Europe is on the gas supplied by Russia, as evidenced by the fact that the stringent and far-reaching sanctions imposed on Russia excluded energy commodities.

Peace talk hopes weigh on oil prices. Source: Refinitiv.

The biggest surprise was the surge in nickel prices to $100,000 a ton and a halt in trading due to the unprecedented short squeeze, highlighting the dislocations that can occur when geopolitical shocks emerge.

Nickel surges to $100,000/ton in historic short squeeze. Source: LME.

The war has also wrought havoc in the grain and fertilizer markets that could have long-standing impacts, including dire food shortages in low-income countries. Already producers are raising prices or seeking to reduce their use of these inputs in response to the restricted supply and steep price increases. Reductions in fertilizer usage in the upcoming planting seasons could see yields decline and so the vicious cycle of scarcity could intensify.

The war on inflation

In the last commentary, inflation is one of the main concerns derived from the Conflict’s escalation. Overshadowed by inflation fears, food and energy price now likely to spiral off already 40-year US inflation highs. The graph below highlights how economists are ratcheting up their inflation forecasts for the OECD countries – to 5.1% currently from the 1.5% expected this year when economists made their predictions in early 2021.

Inflation estimates for major OECD nations. Source: RBC Global Asset Management.

The sharp turnaround from what the Fed expected to be transitory inflation last year to the potential for a return to 1970s inflation highs has resulted in far more hawkish central bank stances in the first quarter of this year. The Fed’s March meeting saw interest rate projections catch up with the more hawkish expectations of the market. The graph below shows a significant shift upwards in the implied Fed funds rate as measured in 12-month future contracts, with consensus expectations now for at least six rate hikes this year and three next. The prospect of a couple of outsized 50-basis point increases is now being factored in, with US central bank messaging paving the way for one at the next meeting.

Implied fed funds rate – 12 months futures contracts. Source: RBC Global Asset Management.

Such an aggressive response to inflation pressures arising out of the pandemic – and now accentuated by the war – has also raised growing concerns that rate hikes will stall the world economy or even drive certain regions into recession, reintroducing the stagflation that haunted the world in the 1970s.

These fears increased in the final week of the quarter as the two-to-10-year area of the US yield curve inverted. History indicates such an inversion (i.e. longer dated yields being lower than shorter dated) is a harbinger of recession. However, opinion is divided on whether this will prove the case on this occasion and how long after the inversion a recession may occur, with many economists saying it could be as much as 18 months to two years ahead. Some economists also suggest that, given the historic levels of monetary accommodation and liquidity introduced into the financial markets, the relationship between an inverted yield curve and economic recession is less reliable than it once was.

Yield curve inversions and recessions. Source: Refinitiv Datastream.

No matter the outcome, the central banks still face the unenviable position of having to prevent expectations of higher prices from setting in while avoiding an economic meltdown. For now, all indications are that the developed economies, particularly the US, are as robust as they were coming into 2022. The latest purchasing manager indices, as shown in the graph below, show that only China’s PMI fell below the 50 level into contraction territory. The US and Europe manufacturing PMIs remain well above that level.

Global purchasing managers’ indices. Source: RBC Global Asset Management.

China’s challenges

After leading the world out of the initial phase of the pandemic, China now faces a host of challenges which have seen its economy and stock market performance diverge from the rest of the world. The Chinese government’s focus has been on trying to repair the damage it did to investor certainty after clamping down on tech and online education companies last year. This comes at a time when it is up against a resurgence of Covid infections. Nonetheless, the government is still confident that it will achieve the above 5.5% growth target (see graph below) that it set for the country and, after providing stimulus to the market, has shown an intention to do what it needs to do to get there.

China targets around 5.5% growth – The economy has never missed its target. Sources: Government work reports; National economic and social development reports; National Bureau of Statistics.

Outlook

The Russia/Ukraine geopolitical shock has brought increased uncertainty to stock markets. However, history has shown the dangers of making negative long-term judgements based on short-term concerns. The graph below shows how the US stock market at least has continued to climb notwithstanding the extremely volatile conditions at times since 2013.

Sources: Fred.stlouisfed.org; Chicago Board Options Exchange; S&P Dow Jones Indices LLC.

Stock markets recover and rally after macro-economic or geopolitical shocks, and it is during these periods that the best investment opportunities often arise.

US consensus earnings expectations for the S&P500 have moderated from their exceptional levels last year, but they remain positive, as shown in the graph below. This plots the month-by-month progression of S&P 500 earnings estimates, which have been moving sideways for the past few months. While the war in Europe continues to devastate the lives of millions, there are nonetheless many companies across the world for which the financial impact is minimal and many others that offer the potential for a significant rebound following indiscriminate selling.

Consensus US earnings estimates. Source: RBC Global Asset Management.

The portfolios’ March performance is as followed:

Fund Name Performance
International Balanced 1.51%
International Growth 2.36%
Natural Resources 8.16%
Gold & Precious Metals 7.21%

Regards,

Euro Pacific Advisors Management Team

Portfolio Commentary: Effects of Ukraine Crisis

Published: March 07, 2022

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Relevant Strategies

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

Our Commentary

Market overview

The anticipation of Russia invading Ukraine knocked stock markets down in February. Share indices fell between 4% and 8% in the days leading up to the invasion on February 24, but then recovered as the initial sanctions announced were seen as being less detrimental to markets than had been feared.

The NASDAQ was the hardest hit, slumping 7.7% in the days ahead of the invasion and standing 14% lower this year. Many European indices are also showing double digit declines, the exception being the FTSE 100 Index which is broadly level. There are increasingly attractive opportunities in European equities with valuations now so low that the risk/reward profile is better than at any time since the financial crisis of 2008.

S&P 500: Since the beginning of the coronavirus pandemic. Source: New York Times.

As expected, Russian assets and the ruble were hard hit by Putin’s decision to go to war, with the ruble-denominated stock market index shedding 54% in the first two hours of trading on the news of the invasion. This time the impact on the Russian financial market and economy is likely to be a far cry from Russia’s annexation of Crimea in 2014 when, after an immediate decline, the stock market went on to rally for the following nine years.

MOEX Russia Index Performance. Source: Refinitiv, FactSet.

The price of Brent crude oil reacted strongly to the crisis, pushing through the $100 a barrel to $105. Dutch TTF Gas Futures prices also soared 70% in the immediate aftermath of the invasion, given Europe’s reliance on Russian gas supplies.

The war and inflation

The conflict is expected to lift global inflation even further through its impact on a large part of the world’s broader commodity and agriculture complex. Russia is a one of the world’s largest oil producers and gains from gold, inflation-linked bonds and global property are partially offsetting declines in equity markets.

CPI forecasts under various scenarios for oil prices. Source: Bloomberg Economics.

The Russia-Ukraine war ousted the US interest rate hiking cycle as the core theme driving financial market sentiment for most of February. However, investors continued to speculate on the future trajectory of interest rates, now factoring in the possible impact of the hostilities in the short term. While markets had begun to price in an aggressive 50-basis point increase in the Federal Reserve fund rate in March, with up to seven rate hikes thereafter, Fed officials have talked down the prospect of a heavy hitting initial rate hike and the market is now pricing in a total of seven rate hikes this year.

Opinion is divided over whether the war will lock in inflation rates at their current highs due to the domino effect higher commodity prices and supply disruptions will have on prices in general. In the last week of the month, the Fed’s preferred gauge of inflation, core PCE, came in slightly ahead of expectations, at 5.2% versus 5.1% but the broad headline rate of 6.1% is a long way ahead of the Fed’s target for average inflation of 2%. The Bloomberg graph below highlights how the US inflation peak could be delayed based on rising oil prices, with CPI forecast to exceed 8% if oil reaches $120 a barrel and to hit around 8% if it remains between $90 and $95 a barrel.

Markets are not at this stage anticipating inflation rates to stay high for the long-term. The price of inflation-linked bonds and derivative contracts in the US reflect the belief that inflation will average 2.5% for the next decade.

Implications of Ukraine crisis

One of the main implications of the Russian assault on Ukraine is expected to be a marked increase in defense spending across the world, which would reverse the steady decline in defense spending as a percentage of GDP globally since the mid-1980s. The implications of such an increase would be that governments would need to re-route expenditure away from social security and infrastructure spending at a cost to the average civilian.

While it is too early to tell whether Russia will achieve its aim of taking over Ukraine, Vladimir Putin’s decision to walk away from diplomatic solutions is expected to alter the geopolitical landscape for the worse in the long term.

Russia and China have been moving away from a reliance on the dollar, with the proportion of trade payments in dollars between the two now only 16% versus 97% in 2014. Russia now has more of its reserves in gold than in dollars.

Developed world countries have introduced stiff sanctions on Russia, Putin, his foreign secretary and the oligarchs in the wake of the invasion. These range from trade sanctions, travel bans, freezing the assets of the wealthy and, most recently, removing most of the country’s access to the SWIFT payment system and freezing the foreign reserves it holds overseas. However, these are not likely to have an immediate impact on the country and some of them are extremely difficult to implement, particularly with regards to sanctions on Russian individuals’ assets.

The dollar-denominated RTS Index following Russian invasion. Source: Refinitiv, FT research.

Of most concern is Europe’s huge reliance on gas supplies from Russia – a situation that is not going to change in the short to medium term. The region has invested heavily in renewable energy sources but is probably decades away from becoming self-reliant on green energy sources. Germany has nonetheless officially halted certification of the Nordstream 2 pipeline, which has been the subject of ongoing negotiation between Russia and Europe.

As a result, Russia has been spared sanctions on energy supplies, which alleviated the impact on the stock market as seen in the dollar-based RTS index of liquid Russian shares in the graph above.

Outlook

Since our exposure to the Russian market is negligible, we are not concerned about its performance in the short and medium term. However, it’s essential to address the potential impacts of the conflict on important factors like inflation and the global economy.

Bloomberg has mapped out different economic scenarios going from bad to worse as a result of the Ukraine crisis.

Scenarios for economic impact of Ukraine crisis. Source: Bloomberg Economics.

Initial indications would suggest the first is unfolding, with Russian oil and gas still available and markets on the up off after their steep sell off. In this event, the Fed is seen as likely to engage in a milder monetary policy tightening regime than currently priced into markets.

Lastly, a scenario in which Europeans are denied access to Russian gas and the world to its oil could well trigger the stagflation outcomes that have been the subject of so much debate during the pandemic. Inflation would become even more of a problem and central bank action would stall growth, perhaps resulting in a hard landing for the global economy.

The portfolios’ February performance is as followed:

Fund Name Performance
International Balanced -0.38%
International Growth 0.10%
Natural Resources 2.74%
Gold & Precious Metals 11.09%

Regards,

Euro Pacific Advisors Management Team

Portfolio Commentary: Favorable outlook after rocked markets

Published: February 08, 2022

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commentary

Relevant Strategies

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

Our Commentary

Market overview

It has been a rough start for the year. Geopolitical tensions between the US and Russia have become increasingly acute, but it is nervous anticipation of the US Federal Reserve withdrawing monetary policy support that has been the main cause of a spike in financial market volatility.

The world’s so-called fear gauge, the CBOE VIX, climbed to last January’s high of 33 during the month but remains much lower than its peak of 66 when the market experienced its COVID 19-related bear market crash in March 2020.

CBOE VIX index. Source: CNBC.

After a bumpy 2021, stock markets ended the new year’s first month in the red. The NASDAQ index was 15% lower at one point, on a rotation from the growth stocks that form most of the index into value stocks. The S&P 500 ended down 5%, China’s SSE Composite was down by 6% and the Japan Nikkei 225 by 7%. The UK FTSE 100 Index was one of the few developed markets not to end lower but the mid-cap index was down by 7%.

Bond prices also suffered and the price of long-dated indices registered declines of up to 7%. Within the typical portfolio, bond exposure has been reduced and is generally short-dated and/or inflation-linked to minimize interest rate sensitivity, increasing other risk factors to generate returns.

The gold price has remained steady while the index of a broad basket of commodities added a further 9% as the oil price soared.

Rate hikes question

The jury is still out as to how many interests rate rise we can expect from the Fed this year, but the number implied by derivative markets has increased steadily from two last year to three and then four. After the first Fed meeting, investors envisage a scenario in which there are five successive rate hikes, coming at each Fed meeting from March.

At the first meeting of the year, Federal Reserve Chair Jerome Powell was careful to emphasise that there was no preset course for rate hikes this year and that the Fed would respond nimbly, “led by the incoming data and the evolving outlook.”

What is clear is that the Fed doesn’t want a repeat of the 2013 taper tantrum. It is going to tread carefully so as not to derail financial markets or the global economic recovery by moving too fast – the outcome financial markets are most jittery about at the outset of 2022.

Rotation from growth stocks into the COVID laggards

Rising interest rates are seen as favoring stocks that offer value based on their net assets over those exhibiting strong growth. This is because many investors and analysts use net-present-value models to value stocks. The rationale is that growth stocks look less attractive on this measure when interest rates rise because their expected earnings are in the distant future and therefore worth less. In this scenario, higher inflation is positive for value strategies because growth companies may benefit less from price hikes, while value companies that have actual earnings can boost profit margins by raising prices.

However, rising interest rates have not been shown to have a long-term effect on equity prices, arguably because a higher discount rate is counter-balanced by a stronger growth rate in cash flows. There is no historical correlation between rate rises and equity market performance and there have been many periods of buoyant stock markets with rising rates. Investors seem nervous now because many have only ever witnessed low rates and strong returns.

Will value stocks continue to outperform growth stocks in this cycle? Source: YCharts.

Outlook

Interest rates will rise as quickly as expected if inflation remains sticky – a situation that will depend on whether:

  • Demand continues to rise unabated
  • Supply constraints remain an ongoing challenge
  • Labour costs continue increasing, setting in motion a wage-price spiral that poses great risk to inflation expectations

We anticipate further volatility in growth stocks in the short term, but the trends accelerated by COVID remain very much in place and when the dust settles there will certainly be opportunities.

Financial markets and the real economy don’t always move in tandem. It is likely 2022 will continue to produce volatile markets as investors fret about whether central banks will remove stimulus too slowly or too quickly, whether inflation will remain too high or fall quickly towards deflation, and whether China will be able to reach an economic glide path without too much turbulence.

Additionally, we think investors may have underestimated the earnings power of many companies who have responded to COVID and supply disruptions with improved delivery of their products and services. Decent profit growth and undemanding valuations in many areas should enable swathes of the equity market to produce positive total returns. Furthermore, many consumers are sitting on piles of cash from fiscal stimulus and capital expenditure, and this factor may fuel further economic and investment activities in the short and medium term.

The portfolios’ January performance is as followed:

Fund Name Performance
International Balanced -4.67%
International Growth -5.49%
Natural Resources 2.34%
Gold & Precious Metals -1.62%

Regards,

Euro Pacific Advisors Management Team

Portfolio Commentary: Strong year for equities ends with gains

Published: January 14, 2022

euro pacific advisors fund manager portfolio 
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Relevant Strategies

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

Our Commentary

Market overview

Most stock markets gained ground in December to wrap up a year, in which equities went from strength to strength while bonds and gold lost value. The S&P 500 rallied a staggering 27% during the year, European and UK market gained over 15% while China was the standout underperformer, sliding 5% after Chinese regulatory clampdowns raised investor concerns about the world’s second largest economy.

Stimulus and vaccines have sent stocks to record highs. Source: Source: Refinitiv Datastream.

US companies had strong third quarter earnings and the fourth quarter is expected to be equally impressive. Earnings growth for the year is expected to be 45%, significantly greater than the 22% growth anticipated a year ago. However, with the S&P500 price to earnings ratio at 28.9, the jury is out on whether similar increases can be achieved this year.

The sectors that outperformed in 2021 were energy – which had a runaway streak from mid-September – financials, real estate and information technology. According to Bank of America, about 65% of the Nasdaq’s gains can be attributed to five tech stocks – Microsoft, Google, Apple, Nvidia and Tesla.

S&P 500 sectors performance. Source: Standard & Poor’s.

Macroeconomic concerns remain

The stellar stock market increases occurred against an uncertain macroeconomic picture, which has faced global supply challenges, rising inflation and central bank moves to start withdrawing trillions of dollars of liquidity that have been propping up the financial markets and buoying investor sentiment.

A significant rise in consumer demand for goods, Covid-related bottlenecks caused by port shutdowns in China and other logistical hiccups led to supply constraints which fed rising prices. These also saw microchips in short supply, with the impact felt across the manufacturing sector and auto companies the hardest hit.

Inflation took over as public enemy number one after initial hopes that supply would catch up with demand after a few months. Considered transitory by most mainstream economists and the Federal Reserve for most of the year, US Federal Reserve Chairman Jerome Powell formally put the term out to pasture in early December, acknowledging that inflation was likely to remain higher for longer.

As a result, the Federal Reserve is increasing the pace of its monetary policy tightening to ensure inflation expectations don’t become entrenched and set in motion a self-fulfilling cycle. The central bank began tapering in November and now expects the process to be over earlier than its original June target date. Chairman Powell also indicated that financial markets could expect up to three rate hikes in 2022.

Global inflation surged in 2021 . Source: Refinitiv Datastream.

In the UK, the Governor of the Bank of England guided the financial markets to expect a rate hike in November but did not deliver, causing significant bond market volatility. Interest rates were raised in December. The European Central Bank remains more dovish.

Central banks will have to maintain the delicate balance between keeping inflation expectations anchored and allowing for a supportive environment for economic growth. As negative supply shocks push inflation higher, they threaten to set off a self-fulfilling cycle of ever higher inflation, which could begin to chip away at demand.

While the global economic recovery continued, the World Bank raised concerns about the uneven rates of recovery, as shown in the graph below. High income countries have managed to recover at a healthy rate and are expected to continue on their upward trajectory. In contrast, low income countries have lagged.

Global economic recovery is expected to be uneven. Source: Global Economic Prospects, 06/2021.

The OECD expects a rebound in global economic growth to 5.6% this year and 4.5% in 2022, before settling back to 3.2% in 2023, close to the rates seen prior to the pandemic.

Omicron’s appearance in December raised economic concerns but hopes that that measures to limit the spread may be more restrained than for previous variants meant financial markets recovered ground and the oil price, which came off $10 a barrel on the day Omicron hit the news, recovered rapidly.

Gas prices rise due to shortages

Since Autumn, gas prices have spiraled in response to global supply shortages. Record high natural gas prices in Europe and Asia were spurred by significant demand ahead of the northern hemisphere winter and unanticipated shortfalls in existing renewable energy production. They were also affected by the geopolitical forces stemming from what is seen as Russia’s attempt to force Europe’s hand by restricting supplies so that it will approve the Nord Stream 2 gas pipeline.

Europe relies significantly on natural gas from Russia and now has to compete with South East Asia for liquid natural gas exports from the US, where there is pressure to halt exports. Most economies, including China, are likely to transition to gas in their journey to becoming net-zero economies and thus demand is only likely to intensify over the next decade.

Energy prices and food prices have risen sharply since the COVID-19 pandemic begins. Source: World Bank Commodity Market Outlook. Note: Data for 2021 and 2022 are forecasted.

Portfolio Actions

Despite December gains, we think markets will be under pressure going to the first quarter of 2022. A few media camps have discussed about the possibility of a market correction in January. We think the possibility of such event’s occurrence is low.

The portfolios’ composition remains unchanged for the month, while we are currently maintaining a comfortable degree of cash in all portfolios (<10%) in case investment opportunities arise. Our December and annual performance are as followed:

Fund Name Performance (December) Annual Return
International Balanced 1.74% 0.62%
International Growth 2.19% 3.83%
Natural Resources 1.42% -0.19%
Gold & Precious Metals 2.06% 20.80%

Regards,

Euro Pacific Advisors Management Team

Portfolio Commentary: Markets Shaken by V.F.I.

Published: December 07, 2021

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commentary

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.

US inflation at 31-year high. Source: Refinitiv.

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.

5-year Brent Crude Oil chart. Source: Tradingeconomics.com.

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.

Current FED plan of asset tapering. Source: Federal Resource Open Market Committee (As at 3/11/2021).

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:

Source: Visualcapitalist.com.

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:

Fund Name Performance
International Balanced -1.44%
International Growth -1.87%
Natural Resources -4.39%
Gold & Precious Metals -2.22%

Regards,

Euro Pacific Advisors Management Team

Portfolio Commentary: Equities recover but challenges lie ahead

Published: November 09, 2021

euro pacific advisors fund manager portfolio 
commentary

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.

S&P 500 P/E ratio remains historically elevated. Source: S&P Global Market Intelligence.

S&P 500 EPS growth YOY. Source: S&P Global Market Intelligence.

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.

Brent crude oil $/barrel. Source: Bloomberg.

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.

Real GDP Growth Baseline Forecasts: 2019-2023. Notes: (1) Regional real GDP growth using PPP weights; (2) figures for 2021 onwards are forecasts; forecasts updated 4 October 2021. Source: Euromonitor.

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.

Inflation Baseline Forecasts: 2019-2023: 2019-2023. Note: (1) Regional inflation using PPP weights; (2) figures for 2021 onwards are forecasts; forecasts updated 4 October 2021. Source: Euromonitor.

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:

Fund Name Performance
International Balanced +2.87%
International Growth +3.38%
Natural Resources +4.26%
Gold & Precious Metals +7.13%

Regards,

Euro Pacific Advisors Management Team

Portfolio Commentary: Markets Decline Under Pressure in Q3

Published: October 11, 2021

euro pacific advisors fund manager portfolio 
commentary

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.

Source: Bloomberg.

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.

Source: FactSet, CNBC.

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.

Source: Bank of England, Refinitiv.

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.

Source: CNN.

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.

Historically, Chinese equities perform well in Q4. Source: Bloomberg.

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:

Fund Name Performance
International Balanced -2.62%
International Growth -2.54%
Natural Resources +0.96%
Gold & Precious Metals -11.47%

Regards,

Euro Pacific Advisors Management Team

Portfolio Commentary: Buoyant Markets Amidst Fizzling Growth

Published: September 08, 2021

euro pacific advisors fund manager portfolio 
commentary

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.

US, Europe stocks brush off China risks, trade near record. Source: Bloomberg.

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.

Are consumers less confident than Wall Street about economic growth? Source: Refinitiv Datastream.

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.

Economic surprises indexes weakens as economic activity slows. Source: Refinitiv Datastream.

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.

Non-manufacturing gauge contracted for the first time since March 2020. Source: National Bureau of Statistics.

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.

10-year Yield slides from 2021 peak. Source: Bloomberg.

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:

Fund Name Performance
International Balanced +1.09%
International Growth +0.95%
Natural Resources +0.64%
Gold & Precious Metals -6.27%

Regards,

Euro Pacific Advisors Management Team