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July Review 2021

Summary

While many financial market commentators have championed China as the area of high growth, we frequently remind people when questioned on this subject that China is not a democracy.

Chinese Takeaway

While many financial market commentators have championed China as the area of high growth (albeit domestically rather than its previous role of global growth engine), we frequently remind people when questioned on this subject that China is not a democracy.  Another sharp reminder of that fact occurred in the second half of July when Chinese authorities stepped up their oversight and control of the technology, private education and food delivery sectors.  Additionally, their focus included the heavily indebted real estate sector where new restrictions were imposed to cool that industry.  The Chinese stock market’s reaction was savage, with Chinese equities easily beating other markets to the wooden spoon for July, posting a negative 13.28% return (source: FTSE).

Thre graphs below and on the following page sourced from The Daiy Shot illustrate the frequency of Beijing’s interventions and their intended targets.  Good intentions, badly handled?  Markets unimpressed and worried about what’s next.

China represents 37.5% of the MSCI Emerging Markets (EM) Equity Index and Tencent, Alibaba and Meituan, three of the top five constituents by percentage weight, represent 11.75% of the MSCI EM index.  It is therefore unsurprising that the MSCI EM Index suffered a 6.54% loss in July.  For those investors pursuing an index tracking and/or geographically based strategy focused on Asia’s (over 75% of the MSCI EM Index) growth potential, July would have come as something of an unpleasant surprise.

Readers will be aware we favour a thematic approach and have done so since TBAM started in 1999.  While thematic investing has become more mainstream over the past year, it has always helped to focus on long-term growth themes irrespective of geography.  Consequently, there has been little exposure to China in TBAM managed funds given the opening comment about China and democracy.  What China may have given investors in the past, it took away a large chunk in July.

What Inflation?!

As we wrote in June’s mid-monthly update, the debate about inflation and how high and for how long it will remain elevated, rages on.  However, government bond markets, especially the US and UK, would suggest it isn’t a problem and support US Federal Reserve Chairman Jerome Powell’s opinion that it is transitory.  The US ten-year yield government bond yield dropped by over 20bps in July.  Ten-year UK gilt yields fell too, but by less.  There was much demand for the safe haven of government debt, including those with an inflation indexation.  This demand is despite real yields being negative in most maturities in most developed bond markets. Volatility in financial markets ebbed slightly in July.  Corporate debt, already at tight spreads to their government counterparts, fared less well.  It seems likely that government debt and to a lesser extent, non-government bonds will be a marketplace where yields will be maintained by central banks at levels below inflation in order to bolster economic activity which currently looks like being historically strong in 2021.  Indeed, the International Monetary Fund (IMF) revised up its 2021 growth for the developed world but downgraded its prospects for developing economies – largely reflecting vaccine availability and the timeliness of restriction removal.  The UK was the biggest beneficiary of economic revisions with growth in the UK economy now projected to be 7% this year.

Earnings

The US second quarter earnings season began in July with many companies beating demanding estimates.  Such good news underlined the attractions of US equities enabling them to counter concerns over rising Delta variant Covid infections impacting economic growth.  As a result, US equities topped the equity charts in July with the S&P500 Index up 2.2%, whereas the MSCI World index was only up 1.4%.

Metals and Oil

Oil oscillated in price at just over $70 a barrel. Low inventories aided the price buffeted by the usual machinations surrounding OPEC discussions. Longer term, fossil fuels remain challenged by the green agenda which continues to gather significant momentum.  Gold had a stronger month, perhaps helped by lower government bond yields.  Industrial metals started the month well assisted by economic recovery prospects in developed economies although many prices dipped towards month end, but they had a good, positive month overall.

Currencies

The US dollar was slightly stronger in July, but currencies exhibited relatively low volatility overall.

Summary

Bonds continue to favour the borrower not the lender/investor for whom they represent a poor investment choice relative to inflation.  Equities aligned to long term themes still look the preferred choice, especially when allied to companies demonstrating excellent free cashflow generation, low debt levels and are not labour intensive or reliant on high sales volumes with low margins.

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