Developed market equities were broadly flat over the quarter after a moderate decline in September erased the quarter’s prior gains. However, this still leaves developed market equities sitting on strong gains for the year to date. Chinese equities have struggled though and dragged emerging market equities down over the quarter, despite some markets, such as India, continuing to perform well.
Equities held up over the quarter despite some concerns about a peak in the rate of economic growth, supply disruptions and rising inflation. Ultimately, investors still believe that, despite a moderation in the pace of growth, recession risk remains low. Expectations for ongoing earnings growth in the coming years are therefore helping to support equity markets.
Exhibit 1: Asset class and style returns
Source: Bloomberg Barclays, FTSE, MSCI, Refinitiv Datastream, J.P. Morgan Asset Management. DM Equities: MSCI World; REITs: FTSE NAREIT Global Real Estate Investment Trusts; Cmdty: Bloomberg Commodity Index; Global Agg: Barclays Global Aggregate; Growth: MSCI World Growth; Value: MSCI World Value; Small cap: MSCI World Small Cap. All indices are total return in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 30 September 2021.
The negative news from China seemed relentless in the third quarter. First, China’s move to turn private tutoring companies into non-profit organisations worried some investors, who started to question whether similar actions could be applied to other sectors. Then, more regulations on the technology sector were announced, including a ban on children playing computer games for more than three hours per week. Finally, investors had to contend with fears around the potential default of a large Chinese property developer and the potential spillover effects. All this has weighed on Chinese equities.
We don’t think that China is likely to prevent companies in other industries, outside of the education sector, from making profits. While new regulations could slow the pace of profit growth for some sectors, earnings overall are still likely to grow robustly over the coming years, just at a somewhat slower pace than would have been the case without new regulation. We also think the exposure of the banking system to the most at risk property developers is manageable and is therefore unlikely to lead to a systemic crisis. So, while all the uncertainty perhaps justifies some of the decline in Chinese valuations that has taken place, we think strong earnings growth will continue to support Chinese equites over the coming years.
Exhibit 2: World stock market returns
Source: FTSE, MSCI, Refinitiv Datastream, Standard & Poor’s, TOPIX, J.P. Morgan Asset Management. All indices are total return in local currency, except for MSCI Asia ex-Japan and MSCI EM, which are in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 30 September 2021.
In the US, the Federal Reserve (the Fed) announced that it will soon (probably in November) begin to slow the pace of its asset purchases, with purchases set to come to an end by around the middle of next year. The Fed also released its projections for interest rates over the next few years, with the central expectation now being for US interest rates to increase to 1.75% by the end of 2024. The pace of rate increases was faster than the market had been pricing in, resulting in a rise in Treasury yields in the days following the Fed’s September meeting, reversing the decline in yields from earlier in the quarter.
In the UK, the Bank of England (BoE) delivered a similarly hawkish shift, suggesting that it could put interest rates up before the end of the year. While we still think it is most likely that UK rates won’t rise before quantitative easing is wound up at the end of this year, the BoE’s latest guidance suggests that a rate rise could certainly come early next year. UK government bond yields moved sharply higher, more than reversing the rally from earlier in the quarter.
The European Central Bank (ECB) announced a reduction in the pace of its asset purchases, but in contrast to the Fed, was keen to stress that this was not the beginning of a process of tapering purchases down to zero. As the Fed and BoE set out on a path towards higher interest rates, the ECB looks likely to be left behind.
Exhibit 3: Fixed income sector returns
Source: Bloomberg Barclays, BofA/Merrill Lynch, J.P. Morgan Economic Research, Refinitiv Datastream, J.P. Morgan Asset Management. Global IL: Barclays Global Inflation-Linked; Euro Gov.: Barclays Euro Aggregate Government; US Treas: Barclays US Aggregate Government - Treasury; Global IG: Barclays Global Aggregate - Corporates; US HY: BofA/Merrill Lynch US HY Constrained; Euro HY: BofA/Merrill Lynch Euro Non-Financial HY Constrained; EM Debt: J.P. Morgan EMBIG. All indices are total return in local currency, except for EM and global indices, which are in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 30 September 2021.
The other main news from the eurozone was the result of the German election. While the outcome means that it could take some time for a government to be formed and the replacement for Chancellor Angela Merkel to be named, we believe the result does mean that the eventual outcome is now unlikely to be a game-changer for German or European equities, with neither the far left or far right parties likely to be involved in the government.
Another place where rates are unlikely to be rising anytime soon is in Japan. Prime minister Yoshihide Suga, whose popularity had declined, announced he wouldn’t lead the Liberal Democratic Party (LDP) into the November general election. His successor, Fumio Kishida, is now seen as likely to lead the LDP to victory in the election. Japanese equities rallied on hopes of further stimulus and economic reopening as Covid cases declined.
Overall, equity markets have proved pretty resilient to the wave of Covid hospitalisations that took place this quarter in many countries, and there are now encouraging signs that the number of people in hospital may be peaking in most key economies. The hawkish shift from the Fed and BOE, along with hopes that we may be at a point where most people have either been vaccinated or already infected with Covid, has caused government bonds to sell off, after their rally earlier in the quarter.
Exhibit 4: Fixed income government bond returns
Source: Bloomberg Barclays, Refinitiv Datatsream, J.P. Morgan Asset Management. All indices are Bloomberg Barclays benchmark government indices. All indices are total return in local currency, except for global, which is in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 30 September 2021.
Clearly, winter brings with it some uncertainty in relation to Covid’s potential impact on health systems but even if hospitalisations do start to pick up again, we expect the economic recovery to be delayed rather than derailed, thanks to still very healthy savings balances that consumers have accumulated. These elevated savings, along with solid wage growth, should also help most consumers to weather the increase in prices currently underway.
So, while there may be some bumps along the way, we continue to believe that the pattern we’ve seen so far this year, of equities outperforming government bonds, is likely to continue between now and the end of next year.
Exhibit 5: Index returns for September 2021
Source: Bloomberg Barclays, MSCI, Refinitiv Datastream, J.P. Morgan Asset Management. Past performance is not a reliable indicator of current and future results. Data as of 30 September 2021.