Are investors taking into account the growing list of concerns?

The political sphere was another area of concern, with investors assessing the potential for a US government shutdown as the country is approaching its debt ceiling. Acrimonious bi-partisan discussions will continue. Beyond the US borders, we saw general elections in both Canada and Germany, while Japan’s prime minister stepped down after only one year on the job. But when all said and done, the landscape has not changed dramatically. In Canada, Prime Minister Trudeau’s Liberal government was returned to power without a majority once again and so we should not expect any major policy shift in the years ahead.

The German election had the potential to have the most significant impact, with a new chancellor being elected after 16 years of Mrs. Merkel being at the helm. As the campaign progressed, polls suggested a shift to the left, bringing hopes for greater unity within Europe and less fiscal conservatism domestically. However, in the end, the race was much closer than expected between the two establishment parties. Potential coalitions to form the next government will likely lean towards the center. Most options include the Free Democratic Party, which supports fiscal conservatism and lower taxes. Coalition talks could last for several months, but the result will likely not be too far from what we have been accustomed to with Chancellor Merkel. In the near-term, the most important driver for the German economy is the evolution of the global economic cycle, as slower global growth and supply chain issues weigh on the manufacturing sector.

On the monetary policy front, Norway became the first developed country in developed markets to hike interest rates.¹ The Norges Bank increased its benchmark rate from 0 to 0.25% and suggested that another hike was likely in December. At the same time, the US Federal Reserve indicated that it would likely begin tapering bond purchases in the coming months and that the tapering will be completed by the middle of next year. Federal Open Market Committee (FOMC) President Jerome Powell made sure to point out that tapering would not equate to higher interest rates. The forecasted path of interest rate hikes remains relatively benign, suggesting that monetary conditions should remain accommodative.

Lastly, a growing number of companies provided investors negative earnings previews due to the rising costs of doing business and supply chain disruptions² that are weighing on profitability. Several large companies³ (Amazon, Walmart, McDonald’s, Costco, etc.) announced wage increases in response to labour shortages. However, supply chain disruptions cannot be as easily resolved, and this issue has moved beyond the semiconductor industry. For example, Sherwin Williams was forced to issue two profit warnings within 3 weeks because higher raw material prices and scarcity are limiting its production capacity⁴. FedEx and Nike also provided a gloomy outlook amid shipping disruptions. The cost of shipping goods has skyrocketed in recent months, while a shortage of truck drivers along with congestion in rail yards and ports have doubled the number of days it takes to ship goods from Asia to North America.⁵

Input costs have risen sharply

Manufacturing PMIs: Input versus output prices

Sources: Haver Analytics, Goldman Sachs Global Investment Research, as of September 28, 2021

Warning Tracks: Dwell times for shipping containers at many US railyards are surging

Sources: Hapag-Lloyd, Bloomberg, as at September 24 2021

Some industries will be more impacted than others by these factors. A study by UBS suggests that a 1% rise in wages will reduce earnings by 1.2%, but such an increase would cause a 6% hit in the transportation industry. The retail and apparel industries are the biggest losers when it comes to rising transportation and logistics costs.

Rising costs of doing business

Impact of rising wages on sectors, and transportation costs across industries

Sources: BEA, Factset, UBS, as at September 28, 2021

Market performance

The string of consecutive monthly gains for global equities was broken last month, ending at 7 due to the MSCI ACWI index’ 3.6% fall in local currencies. Losses were broad-based: US equities retreated 4.8%, while European stocks declined slightly less, with a 3.0% drop. Emerging markets fared marginally better, having only slid 2.8%. In contrast, Japanese equities benefited from renewed optimism emanating from a change in government leadership and, as a result, the MSCI Japan index was up 4.4% in September.

More hawkish comments by FOMC Chairman Powell propelled sovereign yields higher, with the US 10-year treasury yield reaching its highest level in over 3 months and ending at 1.52%. Rising interest rates provided a much-needed boost for some of the most cyclically sensitive sectors, such as financials (-0.8%) and energy (+9.9%). Crude oil prices reached a 3-year high and sharply higher natural gas prices also helped boost energy stocks. The worst performing sectors in September were materials (-6.0%), utilities (-5.6%) and communication services (-5.5%).

The increase in yields proved beneficial to the US dollar, with the DXY index up almost 2%. Most currencies depreciated against the greenback, although commodity-linked currencies fared slightly better. The British pound was the worst performing currency in developed markets, falling 2%.

Conclusion

Given the elevated expectations, investors reacted strongly to negative news. We believe that financial market participants have only just begun to incorporate the long list of headwinds into their forecasts. A shift in expectations could bring more turbulence to financial markets.

We welcome any questions or comments you may have. We can be reached at service@hexavest.com.