The start of the third quarter of 2021 was strong, with many equity markets reaching post pandemic highs. However, Q3 also witnessed the spread of the Delta variant of COVID-19, inflationary fears, supply chain concerns, events in China and the potential removal of the stimulus packages, which many had relied upon to get through the pandemic. The combination of which took its toll on markets, with Asia and Emerging Markets being heavily impacted to the extent where the market finished the quarter in the negative. Developed markets on the other hand took less of a hit and managed to see through the quarter with little change.
Inflationary concerns continued through the quarter, with central banks suggesting the rising inflation was temporary. Investors fearing that the new levels were here to stay added further uncertainty to financial markets. As we move into the final quarter of the year, these uncertainties are expected to continue adding volatility to the mix. Uncertainty in markets discourages cautious investors resulting in large stockpiles of cash, waiting to be redeployed into markets when the time is right.
Q3 2021 index performance
The chart above provides an indication as to how global stock markets behaved over the past quarter. We see a slightly different story compared to Q2, particularly with Tokyo’s Nikkei, which was the worst Q2 performer, but lead the group last quarter. The wider spread Asia and emerging markets indices were clearly more heavily impacted by recent events, particularly by the events we saw in China, and finished the quarter lower than they started. Developed, western markets all experienced a less volatile journey with a relatively smooth quarter finishing with a slight downturn but otherwise positive.
Covid-19 caused significant damage to the global economy, but massive fiscal and monetary support was forthcoming, and helped to prevent a much greater economic event. As the economy gets back to work, bottlenecks, particularly within supply chains, are becoming apparent which has driven inflation higher. Central banks regularly stress many of the drivers of inflation are to be seen as temporary; like the rise in second-hand car prices – which is expected to settle down once the manufacturing of semiconductor chips normalises. In the UK, the return to a normal rate of VAT on hospitality and the rise in fuel costs may mean we do not see inflation peak until the end of the year. The US may have already seen the peak. Central banks have observed inflation go past their 2% targets, in some cases forecasting that CPI will double the current target.
Communism and billionaires might not be seen as natural partners, and the Chinese Communist Party has acted over the last few months to implement a crackdown on large Chinese technology companies and advance its own agenda. Q3 saw the Chinese Communist Party take further action to restrict the activities of Chinese companies selling education outside the state system. Actions to contain the rising property market contributed to the gradual collapse of the Evergrande Real Estate developer. While Evergrande is highly indebted, it is not regarded as a systematic risk like Lehman Brothers. The Chinese authorities have acted fast to contain the damage and we believe the opportunities in China, and Asia more broadly, remain attractive for long term investment. The risk of political interference will be ever-present, but valuations have adjusted to take this into account so the interference becomes less of a concern from an investment perspective.
FCFP Portfolio Performance
The chart above shows the performance of our FCFP portfolios over the most recent quarter. The UK centric FTSE All Share performance is used as a point of familiar reference only. Being UK centric, it brings with it significantly more volatility than our portfolios which are more spread geographically. The portfolios demonstrate a similar journey over the quarter to the way in which developed markets behaved, with a smoother journey across all portfolios across the different risk portfolios. The FTSE All Share shows a greater volatility level, indicative of the uncertain times we find ourselves in. The heightened risk in this case has resulted in a greater return being achieved within the index by accepting a more volatile, and significantly less geographically diverse, strategy.
Longer term performance
To provide an indication of longer term performance, the chart above shows the performance of the FCFP portfolios since their inception at the beginning of January 2020 to the most recent quarter end. The portfolios are all providing returns in line with our expectations and targets for the relevant risk levels, whilst also showing a lower level of volatility when compared with a less diverse option such as the FTSE All Share. The FCFP portfolios continue to adopt a multi-asset, geographically diverse approach to investing, with a particular focus on seeking high quality investments.
As the world adapts to new working practices we need to be weaned off the enormous fiscal and monetary policy support. Central banks are preparing investors well in advance for this and will be aiming to do so without having to hurt global stock markets. The rapid economic gains from a post-pandemic recovery may have already been achieved in many countries as they get back to their regular lives. As a result, from here we could see slower market growth with higher volatility. As we enter the final quarter of the year, we remind ourselves to continue looking through the short-term noise and be mindful of long-term opportunities.
Contributor: Mashud Rahman, Investment Analyst