The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveens 2021 Midyear Outlook :
- U.S. economy: The growth rate has peaked but will remain high throughout 2021.
- Global economy: The economic recovery will spread to Europe and eventually Asia as more countries achieve herd immunity from COVID-19.
- Policy watch: Policy is becoming marginally less accommodative as the recovery takes hold.
- Fixed income: Even with rates subdued, credit-sensitive parts of the market should lead.
- Equities: The best opportunities may now lie outside the U.S.
- Asset allocation: Continue to allocate toward assets poised to benefit from economic reopening and recovery from the pandemic.
Quote of the week:
“At the end of the day, we can endure much more than we think we can.” – Frida Kahlo
Evergrande scare reveals investors’ worries about global growth
Concerns about Evergrande, the world’s most indebted real estate developer, reached a fever pitch last week.4 That’s because the Chinese company was in danger of defaulting on some $80 million of bonds, potentially leading to contagion in China’s real estate sector and broader financial system, and posing a possible threat to global growth.
We can attribute at least some of the recent rise in equity market volatility to Evergrande’s liquidity/solvency problems. Global stocks took a beating on Monday, with the S&P 500 Index (-1.7% for the day), Europe’s STOXX 600 (-1.6%) and Hong Kong’s Hang Seng Index (-3.3%) all dropping sharply before rallying later in the week.5 (China’s stock market was closed for a holiday.)
But as we’ve seen countless times in recent years — even prior to the pandemic — there have been few single events or risk elements that have knocked risk assets like stocks off track for more than a day or two. As a rule of thumb, multiple, independent sources of stress must come to bear for that to happen.
Here are three recent examples:
- 2015: Equity and credit markets sold off sharply as China cracked down on market speculation and devalued its currency, while the Federal Reserve raised interest rates despite lackluster economic data.
- 2018: The S&P 500 narrowly escaped entering a bear market as the U.S. government shut down, the Fed was seen as overly eager to hike rates and global trade uncertainty hit an all-time high, due in large part to U.S. tariffs imposed on China and some close U.S. allies such as Canada and Europe. (A bear market is generally defined as a fall in stock prices of 20% or more from a recent peak.)
- 2020: COVID-19 emerged, financial markets panicked and the S&P 500 lost 34% in just a few weeks before the Fed stepped in to provide open-ended liquidity.6
The highest rate of global growth in decades has been a helpful cushion against volatility in 2021. Not even the late-summer surge in COVID-19 cases, driven by the Delta variant, has derailed stocks for an extended period of time.
Evergrande’s struggles have been well documented for around a year. Yet until last week, investors didn’t regard them as a risk to global growth. What’s changed? The broad economic backdrop. Consider that:
- Evergrande’s latest troubles have coincided with the Chinese government’s desire to manage economic and social policy via increased regulation across a wide range of sectors, most visibly technology and education, both of which were targeted over the summer. Beijing has also made it a top priority to clamp down on excessive borrowing in the country’s property market.
- Central banks globally are gradually beginning to unwind their monetary stimulus.
- The slowing advancement of dual U.S. federal spending bills and the prospect of a government shutdown unless Congress agrees to lift the federal debt limit by September 30 means the ensuing “fiscal cliff” may be even steeper than expected.
- Among countries and regions, inconsistent responses to the rise of the Delta variant this year make it difficult to estimate the rate at which global growth is slowing at the moment.
Despite these challenges, we still believe the positives for markets outweigh the negatives. Global COVID-19 cases are once again in decline as vaccinations rise, and the considerable savings amassed by consumers worldwide over the past year continue to fuel spending growth. In terms of Evergrande’s impact, investors likely hold very few assets with even indirect exposure to the company itself or the broader Chinese real estate sector.
In our view, the main short-term risk Evergrande presents is contagion into global credit markets. This risk appears to be low, if not remote, based on the specific nature of the company’s financial woes and the otherwise solid macroeconomic environment. Last week, developed market credit spreads held steady, and government bond markets showed no signs of panicking.
Evergrande aside, looking further out we’re mindful of a potential slowing of global growth that could be exacerbated by a policy error like a U.S. debt ceiling breach, a too-hasty exit from monetary stimulus by one or more central banks or a sudden withdrawal of fiscal programs by “major players” like the U.S. and China.
We had predicted more challenging stock market conditions overall in the second half of the year — and those conditions have indeed emerged. But the likeliest direction from here remains “up” — just not at the same trajectory investors enjoyed in the first half of 2021.
Fed: “It’s almost time to taper”
Last week, the Federal Reserve met to discuss how to steer monetary policy in an environment of slowing growth and inflation.
In its policy statement, the Fed noted that given the steady drop in unemployment (down to 5.2% in August), “a moderation in the pace of asset purchases may soon be warranted.”7 That’s Fedspeak for “we plan to announce a taper of our $120 billion/month quantitative easing bond purchases on November 3,” the date of the Fed’s next meeting. In his press conference, Chair Jerome Powell indicated that the central bank’s bond-buying is expected to wind down fully by around mid-2022. While this signal was widely anticipated, U.S. Treasury yields rose notably over the balance of the week.
Some market participants may wonder if September’s jobs report, to be released on October 8, will need to significantly top estimates to convince the Fed to stay on course with its “taper timeline.” We don’t think so. Even a tepid-to-moderate payroll gain of 250,000 to 500,000 would suffice if it were accompanied by a further decline in the unemployment rate, and if the reasons for slower job creation (e.g., the Delta variant) could be dismissed as transitory.
In the meantime, the Fed has revised its economic forecasts, which were last updated in June. GDP growth was downgraded from 7% to 5.9% for 2021, but upgraded from 3.3% to 3.8% for 2022. Inflation is projected to rise 3.7% this year (up from the previous forecast of 3.0%) and 2.3% in 2022 (up from 2.1%), as measured by the Fed’s preferred inflation barometer, the core PCE Index.8
In terms of interest rates, half of the Fed’s voting members now believe at least one hike in the fed funds rate will be warranted next year — up from 7 of 18 members in June.9 Although we don’t expect a rate increase until 2023, we acknowledge the risks are tilted toward an earlier “liftoff” if inflation remains well above the Fed’s 2% target.
The cloud hanging over the meeting was President Biden’s imminent decision on whether to reappoint Powell for a second term as Fed Chair when his four-year term expires in February. (Powell was originally nominated to the Federal Reserve’s Board of Governors by then-President Obama in 2012 and was elevated to his current status by former President Donald Trump in 2018.)
He has won plaudits among economists and politicians for his actions to forestall a financial crisis during the early days of the COVID-19 pandemic. Even more important for his chances to retain the job: he has ushered in fairly radical changes to the Fed’s inflation-targeting policy. The upshot of this reform has been the Fed’s increased tolerance of higher inflation and faster wage growth, especially for lower-paid workers.