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Market Commentary

3rd quarter 2021

Reading time 10 minutes
  • Supply is unable to keep pace with demand, pushing prices higher. Even if the current high inflation is considered as temporary, the FED wants to reduce its accommodative monetary policy and support for demand
  • Interest rates rose worldwide in Q3 and led to negative bond markets. The CHF yield curve is still in negative territory, but long-term maturities are approaching zero.
  • Turning point in September: equity markets reacted negatively to rising yields and persistent signs of economic weakness: investors rotate out of highly valued stocks. Swiss equities were among the biggest losers.
  • The Chinese market was under particular pressure due to the ongoing slowdown in economic growth, the government's crackdown on the technology sector and the risk of Evergrande going bankrupt.

Shiny summer

With a strong first half of the year behind them, investors started the 3rd quarter on an upbeat note. Record high inflation was seen as a temporary phenomenon and the slowdown in economic momentum was seen as a guarantee that central banks (especially the FED) would not deviate from their ultra-loose monetary policy. The Covid delta had also lost its horror and its consequences are now seen as manageable. Stock markets continued to rise, reaching new all-time highs at the end of August. At the same time, interest rates fell and yield curves flattened. Like equities, bonds performed well in the first two months of the quarter.

September blues

September saw a change in the mood and attitude of investors towards financial markets. It was triggered primarily by the FED's indication that it might start tapering its monthly market liquidity injection of USD 120 billion as early as November. Everyone actually knew that this moment would come at some point. But in the past, too, investors' pulses rose on this topic as soon as it became more concrete. As a matter of fact, equity and bond markets performed negatively, showing this way a positive correlation over the entire quarter. Interest rates rose, especially for longer maturities. The CHF yield curve is no exception: It remains in negative territory, even though the longer maturities are no longer far from zero.

Developed vs Emerging Market risk awareness

European markets, including Switzerland, ended the quarter with a negative return. The remaining markets, including emerging markets, gave back most of the gains of the first two months in September, but managed to end the quarter on a positive note. Market risk indicators rose only slightly in the developed markets in Q3 and remain below the long-term average. Much more pronounced is the increase in risk indicators and risk aversion in emerging markets and particularly in the largest one: China. This was triggered by the slowdown in economic growth, government intervention in sensitive sectors such as the IT industry, and the impending collapse of real estate developer Evergrande. In contrast to developed markets, investors in emerging markets were much more keen to shift their investments into more defensive stocks. Here, our risk-based strategy delivered the desired protection and significantly outperformed the benchmark index. In the other equity markets, our strategy was in line with or slightly behind the benchmark in most cases.

Are we in for a nasty fall and winter?

It is becoming clear that the weakness of the economy is due to a supply bottleneck that will not be solved any time soon. The fact that supply cannot meet demand is a classic recipe for inflation. So far, the predominant voices are still those that expect demand to decline and see the current inflationary pressure as a short-term effect, also thanks to less expansionary monetary policy. Nevertheless, interest rates are rising. And this time it is associated with a weakening rather than a strengthening of the economy, as was the case last February/March. The combination of rising interest rates and a weakening economy is not favorable for equity markets and particularly for high volatility stocks (e.g. technology stocks).

Better with an extra blanket

Uncertainty in economic variables (economic growth, inflation and interest rates) is increasing. In addition, we are entering a delicate phase with regard to the monetary policy of the most influential central bank, the FED. Equities and bonds currently show a positive correlation, which should be properly addressed in asset allocation. Against this backdrop, we believe that our risk-based approach offers an attractive opportunity to remain invested in the market in a considered and deliberate manner. With an extra blanket, you can better cope with chilly fall/winter storms.

OLZ CIO Carmine Orlacchio

Carmine Orlacchio

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