By Kondi Nkosi
After a rally in July, both shares and bonds turned lower and registered negative returns for the third quarter (Q3). Any hopes of interest rate cuts were dashed as central banks reaffirmed their commitment to fighting inflation. The US Federal Reserve, European Central Bank and Bank of England all raised interest rates in the quarter. Emerging markets underperformed their developed counterparts. Commodities generally declined.
United States
US equities fell in Q3. Communication services, including telecoms and media stocks, was among the weakest sectors over the quarter, along with real estate. The consumer discretionary and energy sectors proved the most resilient.
In July, the market had started to focus on the possibility of interest rate cuts from the US Federal Reserve (Fed) in 2023, given concerns about slowing growth. However, such hopes were dashed at August’s Jackson Hole summit of central bankers, where the Fed reaffirmed its commitment to fighting inflation. This sent stocks lower in the second half of the quarter. The Fed raised the federal funds rate by 75 basis points (bps) to 3.25% in September; the third consecutive 75bps increase.
The Fed’s preferred measure of inflation (the core personal consumption expenditure index) ticked up again in August, from 4.7% to 4.9% year-on-year (y/y). Economic data confirmed that the US economy is in a technical recession, with GDP falling 0.6% y/y in Q2 after a 1.6% contraction in Q1. However, other data showed resilience, such as the August non-farm payrolls report, which showed 315 000 new jobs added that month.
Eurozone
Eurozone shares experienced further sharp falls in Q3 amid the ongoing energy crisis, rising inflation, and consequent fears about the outlook for economic growth. Every sector posted negative returns, with the steepest falls in communication services, real estate and healthcare.
The European Central Bank (ECB) raised interest rates in July and September. Annual inflation for the eurozone was estimated at 10% in September, up from 9.1% in August.
Energy costs continued to be the largest contributor to inflation. Intensified worries over energy shortages also sent the euro to a 20-year low versus the US dollar.
United Kingdom
UK equities fell in Q3. A key event in the quarter was the election of Liz Truss as new Conservative Party leader and hence as prime minister. The new government announced a fiscal package in September, which was poorly received by markets and sent sterling to an all-time low versus the US dollar.
Sterling weakness had already been a feature of the quarter, especially after the US Fed warned it would “keep at it” in relation to raising interest rates. After expectations in July that the peak in US rates might be close, this moved the market’s focus back towards near-term cash flows, such as those offered by the UK’s large-cap constituents.
Japan
After rising through July and August, the Japanese stock market followed global markets lower in September to end the quarter down 0.8%. Other than a brief period in late July, the yen weakened almost continuously against the US dollar, easily breaking the 140 level for the first time since 1998. Meanwhile, the first estimate of GDP showed a quarter-on-quarter annualised growth rate of 2.2%, which was slightly below consensus expectations.
The interest rate differential with the US widened sharply after the successive decisions by the US Fed to raise rates. This differential has been a significant factor in the consistent weakening of the yen so far in 2022.
Asia (ex Japan)
In this region equities were weaker in the third quarter on investor concerns over rising inflation, higher interest rates and fears over a global slowdown. The war in Ukraine and ongoing tensions between China and Taiwan also weighed on sentiment.
China was the weakest index market on concerns over rising interest rates, as countries around the world battle soaring inflation. This was despite data released in September which showed that Chinese factory activity unexpectedly expanded during August. The alarming spread of Covid-19 throughout China also weakened sentiment, prompting fears of further lockdowns as the country continues to pursue a policy of zero-Covid.
Share prices in Taiwan and South Korea were also weaker. In Hong Kong, share prices were sharply lower as investors continued to sell riskier assets for the safety of government bonds. India ended the quarter in positive territory, although concerns over the pace of interest rate hikes by the US Fed weakened sentiment towards the end of the quarter.
Emerging markets
Emerging market equities posted negative returns in Q3, against a backdrop of slowing global growth, heightened inflationary pressure and rising interest rates.
Poland was the weakest index market, with Hungary and Czech Republic also among the biggest decliners, as the Russian war in Ukraine escalated and led to an energy crisis in Europe.
Turkey was the best performing market. Despite inflation that is over 80%, the central bank cut interest rates twice during the quarter and the economy continues to grow strongly.
Bonds
Government bond yields were generally higher and credit spreads wider across the global market, weighing heavily on market returns. (The credit spread is the difference in yield between bonds of a similar maturity but with different credit quality.)
The heightened market volatility during the third quarter continued as central banks and investors continued to grapple with persistent inflation amid a slowing growth backdrop. The US 10-year bond yield rose from 2.97% to 3.83% and the two-year yield from 2.93% to 4.23% in Q3.
The UK’s budgetary announcement accelerated a sell-off as investors questioned the credibility of the government’s fiscal framework. With the gilt market suffering significant losses, the Bank of England intervened by temporarily buying long-dated gilts. Sterling hit an all-time low of $1.03 in the closing days of September before recouping some of its losses.
The UK 10-year bond yield increased from 2.24% to 4.15% and two-year rose from 1.88% to 3.92%.
The German 10-year yield increased from 1.34% to 2.11%.
Commodities
The S&P GSCI commodity index recorded negative performance in the third quarter, driven lower by weaker prices for energy, industrial metals and precious metals. Energy was the worst-performing component of the index, with lower prices for Brent crude oil and unleaded gasoline offsetting higher prices for natural gas.
Prices for aluminium, copper and nickel were all lower, as were those of gold and silver.
Kondi Nkosi is the Country Head of Schroders South Africa.