The impact of the Delta variant continued to subside over the quarter but leaves behind concerns about decelerating economic growth and the continued price impact of supply chain disruptions. Although many forward-looking activity indicators are still in expansionary territory, the momentum in slowdown has gathered pace and will face less favourable base effects going forward. This is especially true in China, with the trajectory worsened by power disruptions. Higher energy prices and ongoing supply constraints has kept input prices elevated for much longer than anticipated, especially for producers. Combined, the idea of peak growth and more persistent inflation has stoked fears of potential stagflation further down the line and a concern that the reluctance of policy makers to acknowledge inflationary pressures as anything but “transitory” will leave them behind the curve.
Market performance (USD)
With this backdrop, it was a turbulent quarter for risk assets which saw volatile periods of recovery and retracement. The S&P 500 declined by 4,7% in September, while the technology heavy Nasdaq 100 lost 5,7% as higher bond yields and chip shortages weighed on technology and other growth stocks. The downdraft in markets left most equity markets down to flat over the quarter with the MSCI World Index advancing a modest 0,1%. Japan stands out for its gain of 3,9% in September as a new prime minister and announcement of November elections raised expectations of increased fiscal stimulus. Chinese markets bore the brunt of weaker economic data which coincided with tighter regulations, energy constraints and the financial distress of Evergrande, one of China’s largest property developers. The concerns spilled over into commodity prices and in turn emerging markets in what proved to be one of the worst quarters for emerging markets since the start of the pandemic. The MSCI Emerging Markets Index lost 8% over the quarter.
Global central banks struck a more hawkish tone in September, with the US Federal Reserve providing indicative timelines for tapering of asset purchases, while the Bank of England (BOE) guided that interest rates might increase even before the end of the year. Norway raised interest rates by 25bps from a record low of zero, the first major western central bank to do so. The US 10-year bond yield increased by circa 20bps over the month to end the quarter at 1,5%, providing a headwind for interest rate sensitive assets. The Bloomberg Barclays Global Aggregate Bond Index returned -1,8% in September.
Winter is coming
A confluence of factors has seen increased prices of energy commodities emerge as a pressure point across several regions. A surge in the oil price has been one of the reasons for higher inflation across the globe and is reaching levels where it could impede further economic recovery. Reaching a three year high in September, improved demand and weather-related disruptions were in part responsible for the rise this year, however supply discipline from the OPEC group has kept prices high.
Much greater pricing pressure, however, has emerged from tight supplies in natural gas and coal, with prices for these commodities soaring. A colder than usual winter in Asia and Europe earlier this year, planned outages of nuclear reactors, delayed maintenance at gas production facilities and lower availability from wind power all combined in gas shortages in Europe which has not been yet replenished ahead of the coming winter. In China, a ban on the import of Australian coal in 2020, regulated electricity prices and tough emissions targets ahead of the winter Olympics in Beijing, has led to local shortages, and coal prices in the region has now hit record highs. This prompted disruption in electricity supply and is adding fuel to global competition for gas and coal. In the face of shortages ahead of winter, demand has continued to climb, and the price of natural gas has risen above that of the equivalent barrel of oil. A mild winter will alter dynamics, but lower investment in traditional energy sources has diminished capacity, perhaps highlighting the need for a more mindful energy transition.
Market performance (ZAR)
A vote for level 1
On the last day of the month, South Africa moved to adjusted alert level 1, further relaxing restrictions on movement and trade. After a ruling by the Constitutional Court, local elections will now go ahead with the Independent Electoral Commission (IEC) confirming the November date.
The economy recorded quarterly GDP growth of 1,2% (not annualised), exceeding market expectations yet again. With growth for the first half of the year ahead of expectations, market participants, including credit ratings agencies, upgraded their 2021 GDP forecasts despite the damage from the civil unrest in July. Activity data released over the month confirmed the negative impact of the unrest in July on the economy and confidence, but forward-looking measures also suggest a recovery underway as businesses get back to operation. The Rand weakened by circa 1,7% against the US dollar in September, while a rise on global bond yields weighed on the local bond market. The South African Reserve Bank (SARB) kept interest rates unchanged but highlighted increased risks to near term inflation. Governor Kganyago again expressed a preference for a lower inflation target, a topic that will no doubt gain prominence. The All Bond Index declined by 2,1% in September, bringing the returns over the quarter to 0.4%.
Bank preference shares rallied over the month after Nedbank announced that it is considering making an offer to buy back all outstanding listed preference shares. This helped the asset class gain 9,6% over the month and 16,7% over the quarter, making it the best performing asset class over the period.
It was a volatile quarter for the local equity market, with regulatory changes in China and moderating global growth weighing on the market’s largest companies and the commodity complex. The resources sector lost 9,5% in September, driving the FTSE/JSE All Share Index down 3,1% over the month. The big drivers of performance over the quarter were losses from index bellwethers Prosus (-14,5%) and Naspers (-16,9%) and a decline in the resources sector (-3,8%), particularly precious metals. With less exposure to global risk factors, domestically exposed small and mid-cap counters outperformed large cap counterparts over the quarter.