Quarterly Market Environment Report


A lackluster quarter for stocks and bonds

Executive Summary

  • The global economy slowed in Q3 as the spread of the delta variant and supply chain issues slowed consumption growth. Growth should recover in the coming months, driven by strong job and wage growth and a gradual return to normal economic life as vaccination rates rise globally. Risks to the global outlook include ongoing supply chain disruptions and surging energy prices, particularly in Europe.
  • Inflation continues to run hot with the CPI increasing by 5.4% over the last year. The US continues to have significant pent-up consumer demand and the supply side is struggling to keep up. Our base case is that inflation moderates near central bank targets over the next couple of years. However, risks to the inflation outlook are tilted toward the upside.
  • Treasury yields were mostly flat in Q3. The FOMC confirmed its intention to begin tapering asset purchases before the end of the year and its “dot-plot was more hawkish than expected. Asset purchases are likely to end by mid-2022. With the economy near full employment, the Fed may have to tighten at a faster pace than implied by the bond market. We expect rates to gradually move higher. This could lead to short-term volatility, but should be manageable for markets and the economy.
  • We remain positive on equities over the intermediate term. The global economy remains in the early/mid cycle of a strong economic recovery, and we expect the current bout of economic weakness to fade over the next few months. However, we are mindful of growing downside risks and suggest trimming any equity overweights.
  • Within fixed income portfolios, we continue to advise lightening up on duration exposure. Corporate credit spreads in investment-grade and high yield remain extremely tight. This might be justified by the economic environment, but there is very limited upside from here.
  • Uncertainty surrounding Chinese growth and policy could pressure EM share prices in the near-term. However, recent underperformance could offer an attractive entry point as valuations appear to discount potential risks and the long-term growth trajectory remains positive. We suggest exposure to the onshore Chinese market, which is less exposed to recent regulatory policies and offers more alpha potential.

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