As we end the third quarter, I thought it would be useful to look back on how markets have moved in the last three months.
The key change is in nominal UK government bond yields where 10-year yields rose above 1%, an increase of 20 bps. In the US and core euro markets, equivalent yields barely moved. UK real yields moved lower in most maturities, although less so at the long end. This pushed up implied UK inflation – a theme that accelerated through September as higher energy costs and labour shortages became more apparent. Other markets saw implied inflation moving higher – but it was less marked than in the UK.
Equities have generally been strong this year but gave ground in Q3. This was particularly the case for emerging markets – especially China, where slowing growth, problems in the real estate sector and government interventions weighed on valuations.
Investment grade credit was still in demand, with credit spreads remaining anchored to their year-to-date lows through most of the quarter. In sterling, returns were negative – wholly reflecting the move up in government yields. Elsewhere, investment grade credit also outperformed equivalent government markets. High yield markets were more volatile, impacted by developments in emerging markets. This was most evident in Chinese real estate where credit spreads moved significantly wider – and this overshadowed an overall constructive period for high yield credit in developed markets.
Thematically the quarter was dominated by central banks preparing the ground for a gradual reduction in quantitative easing and a rise in official rates. This was led by the US Federal Reserve but there were signs, later on, that the Bank of England was becoming more hawkish. One problem for policy makers is their uncertainty about labour market conditions: in many developed economies vacancy rates are exceptionally high. Covid has undoubtedly impacted global work patterns and we are yet to establish what the new normal will be – while Brexit adds further uncertainty for the UK. A pull back from ‘just-in time’ and globally integrated processes may result as businesses build in more contingency – but they will become less efficient, and these costs will be shared between shareholders and customers.
The Conservative Party conference opened yesterday in Manchester. The Free Trade Hall in St Peters Square stands as a reminder of the ideas that drove Manchester liberalism: that free trade would drive a more equitable society and that market solutions were better than government interventions. We have moved on from Victorian values but, economically speaking, this philosophy poses crucial questions for the governing party: what is the role for the State? What level of taxation is appropriate? And how can societies best marshal their resources? The answers will help determine how the UK faces a post pandemic world.
Cash and government bonds
There was a move up in global government bonds yields over the week and despite the rhetoric of higher short-term rates, yield curves steepened. In the US 30-year yields moved above 2% for the first time since early July whilst the UK equivalent hit 1.37%, last seen in May. Core European rates were little changed although yields were a bit higher in Italy and Spain.
UK real yields continued their retreat – the 30-year yield at -2.15% is more than 25bps off peak negativity seen in August. Implied breakeven inflation, however, nudged higher in most markets as concerns about stagflation increased.
Our strategies are generally positioned for a modest rise in government bond yields, and performance largely has been positive. The main negative has been the move up in implied UK inflation at the short end, relative to other markets.
Investment grade spreads widened a bit during the week as risk assets generally sold off. In sterling, spreads widened by 2bps, with weakness reflecting a higher level of issuance. We participated in several primary sterling issues: Investec, Santander, Annington and Southern Housing, reducing positions is some financial bonds. In high yield, spreads widened by more, reflecting sensitivity to risk-off sentiment. In addition, the Evergrande uncertainty added to jitters about the Chinese real estate market.
Performance over the quarter in our credit strategies has generally been good with sector and security selection being more important than any particular view on the direction of interest rates.
To end on a sporting theme. Watching the football over the weekend I was dismayed by the standard of the officials. Perhaps the Prime Minister should issue a few more exemption visas so we get some European refs into system. As the Manchester School would say: competition often raises standards and our officials need more competition by the looks of it.
Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.