July market update...

July was a solid month for global asset markets in aggregate, but also one with large regional divergences and some hard to explain price movements. Equity markets were strong, shrugging off worries over the delta variant and choosing instead to focus on strong earnings and solid economic growth, particularly in the USA. Bond markets were similarly strong, continuing the trend of the month before of absorbing the impact of record inflation numbers whilst remaining simultaneously relaxed about potential policy changes.

“Equity markets were strong, shrugging off worries over the delta variant and choosing instead to focus on strong earnings and solid economic growth, particularly in the USA.”

The bond market performance on the surface reflects the consensus view that the Federal Reserve is managing the return to a more normal interest rate environment well. Many of the headline inflation drivers also do indeed look to be transitory. However, the strength of the bond rally is surprising, even unusual, given the risks that inflation might persist at these high levels is definitely non negligible. Some commentators are taking the bond market price moves as a signal of difficult times ahead, extrapolating a moderation in the pace of economic recovery into a slide into recession or similar. We think it might have more to do with summer illiquidity meeting central bank intervention, causing prices to move further up than they usually would. As many investors head off on holiday and already low liquidity deteriorates further, we wouldn’t be surprised to see volatility continuing until a snap back in yields to higher levels as we head into Autumn.

Regionally there were sizeable divergences intramonth, with Chinese and Asian equity markets sharply underperforming their Western counterparts. The reason was the ‘shock’ intervention of the Chinese authorities, who effectively turned the quoted private education sector into a not-for-profit business overnight by decree. This follows on from interventions late last year in the technology sector, where regulators undertook a series of actions designed to deter and control monopolistic practices. The combined effect was to send Asian and Chinese equity markets sharply into negative territory as investors fretted over which companies would be next to have their wings clipped.

“Given that healthy and attractive capital markets are a necessity for China, we don’t think that this issue will spiral out of control.”

These actions seem to us to be the inevitable catching up of the regulatory system with the growth of the ‘new economy’ in China. Actions to promote social welfare by limiting the influence and pricing power of the new consumer technology or finance sectors are a core part of the Chinese Communist Party policy. Investors in China can sometimes seem to forget that capital markets here have, and always will have, active government intervention in pursuit of political goals. Given that healthy and attractive capital markets are a necessity for China, we don’t think that this issue will spiral out of control – and there was some backtracking post the stock market falls – but there will be a need for a careful assessment of exactly how this risk is priced going forward.

Portfolio Performance

Portfolios produced positive returns at the lower end of the risk spectrum and flat or small negative returns at the higher end. This was behind markets in aggregate as a consequence of our relatively high equity exposures in the Asian region, which underperformed as described above. Although our core managers outperformed Asian indices, they still produced losses which were enough in size to offset the strong returns from the UK and US. Emerging market managers were also weak, given that they also tended to have large exposure to emerging Asian markets. The net result for higher risk portfolios was a disappointing month, but not one that caused particular damage to your capital. Given the valuation reset and the attempts by Chinese authorities to calm frayed nerves, we will be sticking with the exposures, given the regions’ still solid long term growth prospects.

On behalf of the Saltus Investment Committee, August 2021