Market Review

Global Markets Quarterly Update
Third Quarter 2021
Key Insights
  • Global markets were mixed in the quarter as the spread of the delta variant slowed the rebound in many economies.
  • Inflation and interest rate worries weighed on sentiment as central banks prepared to take the first steps in normalizing monetary policy.
  • Tough new regulations on Chinese technology-related firms resulted in some global volatility, but corporate earnings growth generally remained robust.

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U.S.

A sharp pullback from record highs late in the quarter left the major benchmarks mixed for the period. Growth shares outperformed their value counterparts, except among small-caps, while large-caps outperformed smaller-caps. Financials and utilities performed best within the S&P 500 Index, while industrials and business services and materials shares recorded the biggest losses.

Stock and bond prices fell late in the quarter as longer-term U.S. Treasury yields increased, with the yield on the benchmark 10-year U.S. Treasury note hitting its highest level since early June, on the eve of the latest wave of the coronavirus pandemic. Yields moved higher after Federal Reserve officials announced on September 22 that they would soon consider tapering the central bank’s purchases of Treasuries and mortgage-backed securities, a move that would reduce some downward pressure on longer-term interest rates.

Inflation and Rate Worries Grow as Economy Reopens

Investors kept a wary eye on inflationary pressures throughout the quarter. Stocks fell back on July 13, for example, following the release of data showing that headline and core (excluding food and energy) consumer prices jumped 0.9% in June, roughly twice consensus estimates. It was the fastest 12-month increase in the core rate (4.5%) since 1991. June producer prices rose 7.3%, the largest increase since the series began in 2010, as manufacturers continued to encounter higher input prices.

The lingering effects of the pandemic appeared to be behind the spike in inflation but through different mechanisms. On the one hand, persistent supply chain problems, including soaring shipping costs, raised prices for both inputs and finished goods. On the other hand, the release of pent-up demand for travel, recreation, and other services pushed prices higher, although the new wave in coronavirus cases that began early in June appeared to cool both growth and inflation pressures. New cases peaked in mid-September, however, and many experts predicted further declines due to both acquired immunity through infection and vaccination.

Job Growth Slows as Delta Variant Spreads

The slowdown in the economy was most apparent in the labor market. The stock indexes reached their record highs in August, following news at the start of the month that employers had added 943,000 jobs in July, well above consensus estimates and the best showing since strict lockdowns were eased in the summer of 2020. Payroll growth fell dramatically in August, however, with only 235,000 jobs added. The impact of the delta variant of the coronavirus was clear, as hiring in leisure and hospitality ground to a halt. Weekly jobless claims fell through much of the quarter but began climbing again in early September.

Worries that corporate profit growth was also likely peaking may have further contributed to the late-quarter weakness. According to FactSet, overall profits for the S&P 500 rose nearly 90% in the second quarter versus the year before, the best showing in over a decade, with roughly 87% of firms topping analyst expectations. Most observers expected coming year-over-year comparisons to be much more difficult, and worries grew about rising wage and input costs.

Finally, diminishing fiscal stimulus hopes may have contributed to the market’s drawdown to end the quarter. On August 10, the U.S. Senate passed a roughly USD 1 trillion bipartisan infrastructure package, including about USD 550 billion in new spending, that aims to rebuild traditional transportation infrastructure. Senate Democrats separately approved a USD 3.5 trillion budget resolution, the starting point for a reconciliation bill that would address administration priorities, such as improving access to education and increasing support for families with children. The bills stalled in the U.S. House of Representatives, however, as Democrats debated whether to tie together the passage of the two spending packages. Delays in raising the federal debt limit also hampered sentiment.

Europe

Shares in Europe crawled higher to a record level in volatile trading on hopes of a continuing economic recovery. However, growing worries about persistent inflation and how central banks might respond caused a sharp reversal in September, eroding most of the quarter’s gains. Major indexes in France, Italy, and the UK also advanced. Germany’s main index fell.

ECB’s Lagarde Warns Against Overreaction to Inflation; Pandemic Bond-Buying to Slow

The European Central Bank (ECB) said that it would move to a “moderately lower pace” of emergency bond purchases after a rebound in growth and inflation. ECB President Christine Lagarde said that this was not a tapering but a “calibration” of the pace of purchases to deliver favorable financing conditions. She remained cautious on the economic outlook, saying, “We are not out of the woods.” In Lagarde’s view, the risks to the outlook are “broadly balanced” and “price pressures are building only slowly.” The ECB raised its forecasts for growth and inflation, predicting the latter would peak at 3.1% in the fourth quarter of 2021 before slowing to 1.5% in 2023. Official data showed eurozone inflation surging to 3.0% in August. However, Lagarde acknowledged in testimony to the European Parliament that inflation in the eurozone could exceed the central bank’s forecasts, which have already been raised twice this year. Even so, she stuck to the official forecast that an increase in inflation would be temporary. Later, at the ECB’s annual forum, Lagarde said it was important not to overreact to transitory supply shocks that are boosting inflation.

Norwegian, UK Central Banks Strike More Hawkish Stance

Norway became the first G-10 country to tighten its monetary policy, with the central bank raising its key short-term lending rate to 0.25% from 0.00%. Norges Bank Governor Oystein Olsen said there would probably be another increase in December.

The Bank of England (BoE) kept its key rate unchanged at 0.10%, although two policymakers backed an early end to quantitative easing. The accompanying statement also indicated that some developments, including upside risks to the inflation outlook, had strengthened the case for tightening. Inflation in the UK jumped to 3.2% in August, its highest level in more than nine years, forcing Governor Andrew Bailey to explain in a letter to the Chancellor of the Exchequer why it was above the 2% target. He wrote that the BoE now expects “inflation could remain above 4% into the second quarter of 2022.” T. Rowe Price International Economist Tomasz Wieladek believes that some policymakers could vote for a rate hike in November and that all of them could vote for one in February.

Germany Faces Months of Coalition Haggling

The left-of-center Social Democratic Party (SPD), led by Olaf Scholz, won the German general election by only a small margin. The SPD and the center-right alliance of the Christian Democratic Union and Christian Social Union (CDU/CSU), in power for 16 years, are now expected to vie for the support of the Green Party and liberal Free Democrats to form a majority coalition government—likely a lengthy process. Angela Merkel will stay on as a caretaker chancellor.

Japan

 

Japanese equities rose over the quarter, outperforming their developed market peers. The Nikkei 225 Index gained 2.30% while the broader TOPIX Index was up 4.46%. Performance was notably strong in September, after the resignation of Prime Minister Yoshihide Suga raised hopes that his successor would bring in new measures to boost the economy. The country’s accelerating COVID-19 vaccination program also boosted sentiment. The yield on the 10-year Japanese government bond ticked up slightly, to 0.07% from 0.06% at the end of the prior quarter, while the yen depreciated slightly to around JPY 111.28 against the U.S. dollar (from around JPY 111.11 at the end of June).

Yoshihide Suga Resigns as Prime Minister

Amid mounting criticism of his government’s handling of the coronavirus pandemic, Prime Minister Yoshihide Suga announced his intention to resign in September. He said he would not seek reelection as leader of the ruling Liberal Democratic Party (LDP), setting the stage for a leadership election. Toward the end of the month, former Foreign Minister Fumio Kishida beat Taro Kono, who has been in charge of Japan’s COVID-19 vaccine rollout, in the leadership runoff. The victory gave Kishida a nearly certain path to succeed Suga as Japan’s prime minister as the LDP-led coalition has a majority in Parliament.

Setting out his policy platform, Kishida said that while the deregulation and structural reforms promoted by Suga and his predecessor, Shinzo Abe, undoubtedly yielded results, his focus would be on properly distributing the fruits of growth to prevent disparities from widening. He called for a massive stimulus package—of more than JPY 30 trillion (USD 270 billion), according to some reports—to cushion the blow from the coronavirus pandemic.

As Political Leadership Changes, BoJ Chief Affirms Stimulative Monetary Policy

Bank of Japan (BoJ) Governor Haruhiko Kuroda said a new prime minister will not cause the central bank to change its policies. Kuroda’s comments at an ECB conference came just a few days after the BoJ’s latest policy meeting, in which it announced it was continuing its asset purchase program at current levels while keeping interest rates very low. “Whatever fiscal, regulatory, or any other policies the new government pursues, the BoJ will continue to maintain extremely accommodative monetary policy in order to achieve its 2% price stability target as soon as possible,” Kuroda said.

Q2 GDP Revised Upward; Manufacturers’ Confidence Falls as Carmakers Suffer From Chip Shortage

On the economic data front, second-quarter gross domestic product (GDP) growth was revised up to an annualized 1.9%, from a preliminary reading of 1.3%. Separate data showed that confidence levels among Japanese manufacturers fell to a five-month low in September, with the Reuters Tankan Index falling to 18 from 33 in August (the index readings are derived by subtracting the percentage of respondents who say conditions are poor from those who say they are good). Weakness was attributable to the latest coronavirus wave, with activities and broader demand impeded by the health crisis, while carmakers reported the deepening impact of a global semiconductor chip shortage. Some manufacturers have also had to contend with higher raw material prices.

China

Chinese stocks slumped in the third quarter as Beijing unleashed a regulatory offensive against major technology firms and other influential industries in the name of ensuring social stability and national security. The MSCI China Index of U.S.-listed stocks slumped about 18%, while its local currency-denominated index shed nearly 4%.

Stocks plunged in late July after the State Council—China’s equivalent of a cabinet—announced new regulations for the after-school tutoring industry that caught investors off guard. For the rest of the quarter, a raft of new regulations impacting a variety of sectors triggered periodic bouts of selling from investors uncertain about what areas the government would target next. Industries that found themselves under increased regulatory scrutiny included internet platforms, private education, online gaming, video streaming, food delivery, ride hailing, pharmaceuticals, and alcohol producers. Citing national security concerns, Beijing also began to limit which Chinese companies would be allowed to list overseas.

 

Bond Yields Fall as Growth Slows

On the economic front, monthly indicators for July and August largely missed expectations and pointed to slowing economic growth. The People’s Bank of China (PBOC) kept loan prime rates unchanged in the third quarter. The combination of new coronavirus outbreaks and the stock market sell-off led to a drop in bond yields in July before they trended sideways for the rest of the period. The yield on the 10-year Chinese government bond fell 21 basis points in the quarter to 2.89%. In currency trading, the renminbi was broadly stable and traded within a narrow RMB 6.43 to RMB 6.50 range versus the U.S. dollar. China’s large current account surplus and net long-term portfolio inflows have helped support the currency, according to foreign exchange analysts.

Property Developer Problems Unlikely to Spark Systemic Risk

Speculation about a potentially chaotic debt resolution for cash-strapped conglomerate China Evergrande dominated headlines. In response to the growing crisis, the PBOC injected RMB 750 billion of liquidity into the financial system from September 17–29 and pledged to ensure a “healthy property market” and protect homebuyers’ rights in a statement following the central bank’s quarterly monetary policy committee meeting.

Despite the magnitude of Evergrande’s liabilities, which totaled USD 304 billion at the end of June, T. Rowe Price’s analysts do not believe that Evergrande poses a systemic risk to China’s economy as its debt accounts for a small fraction of total banking assets. On the other hand, Beijing will likely focus on addressing the social unrest from Evergrande’s unfinished housing units and the suppliers in the property supply chain that are owed money by the company.

Other Key Markets

Peru Declares Election Winner

Peruvian stocks, as measured by MSCI, returned -11.02% in the third quarter versus -7.97% for the MSCI Emerging Markets Index.

 

On July 19—after weeks of voting fraud claims, protests, and new criminal investigations—Peru’s electoral authority, the National Jury of Elections, finally declared socialist teacher Pedro Castillo as the winner of the presidential election. The first round of voting was held in April; in the June 6 runoff election, Castillo defeated right-wing politician Keiko Fujimori by less than 50,000 votes.

In his inauguration speech, President Castillo outlined the goals for his administration. While he discarded nationalizations and foreign exchange controls, it appeared that he would still want to impose price controls over gasoline and medicine, write a new constitution, and intervene in the mining sector by making the state a majority partner in various projects. Investors appeared concerned by an absence of fiscal discipline in Castillo’s speech, as indicated by promises of enhanced health care, education, and pension benefits. On the positive side, Castillo would look to strengthen Peru’s social safety net, promote rural development and national production, protect minority groups, and safeguard the environment. His main challenge will be to pass most of this through Congress, given that legislators have little appetite for creating a new constitution.

Toward the end of the quarter, Peruvian assets were hurt in part by rising longer-term U.S. interest rates, a weaker currency versus the U.S. dollar, and bearish global sentiment toward risk assets. The markets were also pressured by heightened uncertainty regarding Peru’s political situation; T. Rowe Price emerging markets sovereign analyst Aaron Gifford has noted that fissures are becoming more evident within Castillo’s cabinet and party. Specifically, there have been conflicting comments and opinions among Castillo’s allies about nationalizations and rewriting the constitution.

In addition, despite indications that Julio Velarde—one of Peru’s top economists—will remain at the helm of the country’s central bank, no official pronouncements have been made yet. According to different sources, it seems that he has asked for guarantees from the president that include the nomination of board members that he would work well with, even if they clash with the ideology of some of Castillo’s more radical allies.

Brazilian Stocks Drop Steeply

Stocks in Brazil, as measured by MSCI, returned -20.15% and underperformed the MSCI Emerging Markets Index. Investors were cautious throughout the quarter due to factors such as corruption allegations regarding the government’s purchases of coronavirus vaccines, the government’s struggles to provide additional pandemic-related financial assistance to lower-income families while adhering to a mandatory spending cap, and political tensions between the Bolsonaro administration and the judiciary.

One of the most significant factors weighing on the financial markets was elevated and rising inflation. While this year’s inflation acceleration might have started out as price shocks involving food, fuel, and electricity, T. Rowe Price Sovereign Analyst Richard Hall sees some pretty clear evidence of secondary impacts on inflation. Adding to Brazil’s inflation pressures during the third quarter were utility surcharges passed on to customers. In July, the country’s electricity regulator initiated a 50% increase on an existing tariff surcharge; in late August, the regulator announced the creation of a new “water scarcity” surcharge stemming from low reservoir levels that limit hydroelectric power generation.

In response to the broad price pressures, the central bank raised its key interest rate by 100 basis points (one percentage point) in early August and again in late September. These actions increased the benchmark Selic rate, which had been as low as 2.00% in March, to 6.25%. In their September 22 post-meeting statement, policymakers signaled that they expect to raise the Selic rate by another 100 basis points when they meet again at the end of October. Also, they indicated that they expect this cycle of rate increases to go into “contractionary territory,” which Hall considers to be a bit more restrictive than their previously stated intention to raise the rate to “above neutral.”

Major Index Returns

Total returns unless noted

Major Index Returns Chart

Past performance is not a reliable indicator of future performance.

Note: Returns are for the periods ended September 30, 2021. The returns include dividends and interest income based on data supplied by third‑party provider RIMES and compiled by T. Rowe Price, except for the Nasdaq Composite Index, whose return is principal only.
Sources: Standard & Poor’s, LSE Group, Bloomberg Barclays, MSCI, Credit Suisse, Dow Jones, and J.P. Morgan (see Additional Disclosures).

 

What We’re Watching Next

The past few months have brought several negative surprises, including the rapid spread of the delta variant of the coronavirus and more political uncertainty around the globe, notably a regulatory crackdown in China. Nevertheless, the outlook appears to be favorable on balance for most of the world’s major economies over the coming months. Indeed, the delta variant seems likely to have only delayed rather than derailed the global recovery—perhaps making growth over coming quarters modestly more robust than it might otherwise have been.

There are challenges on the horizon, however. Chief among them is the withdrawal of extraordinary monetary accommodation in the U.S. and other developed markets. The level of monetary stimulus in the global financial system as measured by central bank balance sheets and growth in the money supply peaked earlier this year. The decline in accommodation will accelerate when the Federal Reserve begins tapering its asset purchases, probably in November. Additionally, the European Central Bank (ECB) recently announced it would move to a “moderately lower pace” of emergency bond purchases.

How today’s elevated bond and equity valuations will respond to the normalization of monetary policy is an open question. Past tapering episodes have often, but not always, sparked market corrections. In this instance, central banks are walking a tightrope. In order for the bull market to survive, the Fed’s actions will have to be carefully communicated, result in a measured rise in interest rates, and be accompanied by continued growth and moderating inflation.

The fiscal situation remains as clouded as ever. As of this writing, the U.S. infrastructure bill remains on hold, while jitters are likely to grow again once an end looms to the temporary increase in the federal debt limit, which will probably run out in December. Conversely, the passage of both substantial physical infrastructure and social spending bills would add to the recovery, but likely at the cost of even further elevated debt levels and a higher tax burden. The grimmest—if unlikely—outcome over the longer term would be a loss of confidence in the U.S. dollar. I am mindful that our ability to short-circuit a deep recession after the outbreak of the pandemic relied on the Fed’s ability to monetize the nation’s debt without sparking inflation.

While fading stimulus might pose some challenges for investors, it also presents opportunity by making markets more efficient. Extreme monetary stimulus from the Fed and other central banks has interfered with price discovery by introducing a major buyer that is completely price insensitive. In particular, the Fed’s commitment to buy USD 80 billion in Treasuries and another USD 40 billion in mortgage-backed securities (MBS) every month no matter what has made the real “price” of both unknowable. This has been a boon for homeowners in the case of MBS, perhaps, but a problem for investors given that Treasuries form the reference price for assets globally.

The flood of liquidity has clearly led to speculation in some parts of the market, but it is difficult to generalize about where these pockets of excess lie and how to avoid them. For example, I do not have a strong view on the relative appeal of growth stocks relative to value shares. While growth stocks’ valuations are very high relative to history, so are the earnings growth rates of some innovative companies. Similarly, it is difficult to make blanket statements about the relative appeal of developed versus emerging markets or U.S. versus non-U.S. investments. In my view, the strong recent performance in some asset classes is another argument for maintaining a highly diversified portfolio.

Indeed, the return of price sensitivity in global markets bodes well for selective investors focused on fundamentals. While I do not expect robust overall equity returns given the market’s elevated valuations, I am also mindful that investors have not yet enjoyed all the potential fruits of the recovery. Many companies have yet to see business return to pre-pandemic levels, and identifying which ones are either regaining their footing or disrupting markets through innovation will be key. I’m confident our global research organization will serve our investors in this environment.

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