October 2021 - Not only leaves are falling
September is acknowledged in the markets to be the worst month of the year. It’s called the September Effect. This time again, it didn’t bypass the rule and last month was indeed negative across the board for both equity and bond markets. Mostly impacted was the tech sector, because of higher treasury yields implying higher rates and thus weighing on growth companies’ future relative returns.
The other reasons for this pullback included the global resurgence of COVID-19, supply chain issues and concerns around the withdrawal of Central Banks’ support. On top of that, the US is in somewhat of a political crisis. After a shutdown had been avoided in extremis last week, the Congress has now two weeks to avoid what could be a first US default. In order to do so, the Republicans must agree to increase, or at least to suspend, the debt ceiling. For now, they are playing with fire and unless they join the Democrats in voting to raise the debt level, the US could face a catastrophe and historic consequences, namely a US Treasuries’ default. Of course, a US default would have itself systemic consequences and the global impact on capital markets could possibly be much worse than any Pandemic or Subprime Crisis. However, to put things in perspective, this scenario has occurred before, in 2011 and in 2013, when Republicans tried to put pressure on the Obama administration. Eventually it ended in the extension of the Treasury’s capacity. Finally, even without Republicans, Biden can invoke extraordinary measures to increase the debt limit. Therefore, even if it creates some turmoil in the near term, a US default is highly unlikely.
Central Banks’ meetings last month were pretty much in the same tone than before and with the same focus: the fast recovery allows to gradually tighten the policy and reduce the support; inflation now appears less temporary than expected and price pressures could probably continue into 2022. An interest rate hike is not imminent, and we wait for November’s meeting to have more details and timeline about the Fed’s tapering.
September was also the month of some international political changes. In Germany federal elections were held and for the first time in 16 years, Angela Merkel’s CDU party was defeated and lost its majority. Olaf Scholz of the center-left Social Democrat Party won the elections and talks are now being held to form a coalition either with the Free Democratic Party or with the Greens.
In Japan, elections also took place after Suga announced he was quitting his post of President of the LDP (Liberal Democratic Party), the majority party in the National Diet (the Japanese Parliament), and by doing so, automatically ended his term as Prime Minister after only one year. Since then, the former Foreign Minister, Fumio Kishida, won the leadership race of the LDP and therefore became Japan’s new Prime Minister. Kishida is known to be market friendly, however he was left with quite a lot of economic issues to resolve and so some tough measures could be taken soon by the new administration.
As for China, if when the month started, some investors seemed to think that a certain balance was reached between political control and market efficiency, by the end of the month, the Evergrande huge debt crisis again overwhelmed the general sentiment. One of the most dominant Chinese companies in the most important sector (Real Estate accounts for 30% of Chinese GDP), gave us all a great example of how dangerous corporate debt could be for the entire economy when it is not limited. And we can’t help thinking about how ironic this whole story is: after a full year of efforts of cracking down on tech companies and setting other harsh regulations to make profitable companies non-profit organizations, the biggest threat was in fact in the highly leveraged companies, one issue regulators didn’t take care of. The outcome of Evergrande’s crisis could be what will define what’s next for China.
From our side, as we continue to see record inflows to US equity ETFs, and while the current concerns over a potential US default seem to have little chance of materializing, we find that any pullback offers buying opportunities, whether it’s in strong companies moving down with the market or into bonds offering higher yields after the sell off. Also, if September unfolded by the book, then maybe we can follow the rule and expect a positive fourth quarter, as historically the last quarter is the best quarter of the year.
As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance.
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