In this month’s investor update, our senior wealth manager, Holly Graham, speaks with chief investment officer, James McManus, about how the relatively muted overall portfolio returns for July mask the underlying stories of significant volatility in emerging markets, a strong Q2 earnings season and a continued trajectory of economic recovery in developed equity and bond markets.
How did markets perform in July?
Looking at overall portfolio returns for July wouldn’t necessarily give you an indication of the movements that have taken place under the surface, but it’s been a busy month in financial markets. While developed equity markets have continued their positive trajectory, returning around 1.1% for July, emerging market equities saw significant volatility, delivering returns of –7.3% for the month. Leading the losses was China, down close to 14%, the worst one-month loss for Chinese equities since 2011. Meanwhile in developed markets, Nordic equity markets have led, while US growth stocks and UK mid-caps also performed relatively well in July.
In the bond market, the positive run for government bonds has continued with both UK gilts and US treasuries delivering positive returns in July. That also boosted higher quality corporate bonds but elsewhere in bond markets returns have been relatively muted.
July has seen a little more market volatility than we have been accustomed to of late, but it’s an important reminder that this is simply a natural part of investing in financial markets – we tend to forget this in periods when markets trend upwards more broadly. But in terms of the wider picture, the level of volatility in financial markets remains relatively muted at present – the markets favourite measure, the Vix (or volatility) index, remains around its 10-year average level. Clearly emerging markets have been more volatile in the near term, but we haven’t experienced a period of broad-based volatility in July.
What were the main drivers behind market movements in the month?
In developed equity and bond markets, the story has really been dominated by two things: the continued trajectory of economic recovery, and a strong start to Q2 earnings season towards the end of the month. We did witness some limited volatility in the middle of July as investors contended with both mixed signals from economic data, and fears over the spread of the Delta variant and how that should impact expectations for economic recovery. We expect some volatility to persist as we find our way through the reopening process – the nature of the current environment makes forecasting difficult, and we’re likely to continue to see Covid related issues persist in different ways in coming months.
In emerging markets, the story has been very different. Despite concern over rising Delta fears in economies that have lower vaccination rates, really one other topic has dominated, and that has been the policy approach of Chinese regulators towards certain industry sectors and towards the thorny topic of Chinese companies listing overseas. That has spooked investors in the Chinese equity market as the regulatory clampdown has broadened, and it has caused steep falls in the prices of many leading Chinese technology and internet related businesses effected by the policy change.
China is central to most investors’ views on emerging markets because of its relative size – it accounts for over 30% of emerging stock market indices by size, and within the Chinese market technology and internet focused businesses dominate – the likes of Alibaba, Tencent, Meituan all have significant weightings in the index. And many of these companies have seen negative share price impacts in July as investors come to terms with new Chinese policies intended to curb excesses and, in some ways, recognise the interests of the communist party itself.
Certainly, we are in the eye of the storm as markets digest the news, and there may yet be more policy announcements to come. But losses have already come quickly, and medium term we still expect these businesses to continue to be able to grow under a more mature regulatory structure - the recent policy moves are unhelpful in the near-term, but not necessarily impediments to long-term growth, particularly for the mega cap companies with more diverse business models.
It’s always worth remembering that investing in emerging markets is a long-term activity. We believe emerging markets still stand to benefit from a catch-up effect and the continued recovery in global trade. Inventories are running at record low levels and restocking those in coming months will lean on emerging market supply chains. Covid certainly remains a concern, but vaccination rates will accelerate in the second half of the year, and export activity will be supported by strong developed market demand as economies reopen where vaccines have been distributed. And medium-term, emerging market nations retain large populations that will sustain domestic demand and drive wealth creation. So, there is certainly more to emerging markets than China, but clearly it has been a challenging period for some Chinese equities in July and so far this year.
July also saw some of the world’s biggest companies report Q2 earnings, with some disappointing news from Netflix and big results from the tech giants – Apple, Google, Microsoft and Facebook. We also saw US GDP undershoot expectations towards the end of the month. What did we learn in July about the pace of economic recovery?
As is often the case it’s the mega cap companies that attract the headlines but what we have been looking for is the overall results from earnings season – just how broad based is earnings growth across economic sectors and are all types of companies participating in the recovery? So far, with around 50% of companies having reported results in the US and Europe, its relatively good news.
In the United States, we’re seeing aggregate earnings growth of close to 100% year-on-year. That’s just short of 20% better than the market expected. And in Europe, earnings growth is running at a staggering 170% year-on-year, around 30% better than analysts expected. So, the picture emerging from companies themselves is a relatively robust one.
That also pairs with the macroeconomic data, which on the whole has continued to be encouraging, particularly the ongoing strength in trade activity, and the recovery in key labour markets as emergency employment schemes wind down. In the final days of the month, we saw strong second quarter GDP numbers in Europe, and the US registered Q2 GDP of 6.5% quarter on quarter. On its own, that would be a relatively strong level, but market expectations were significantly higher than that. However, we don’t think this is cause for concern – the consumption data in the GDP report showed US consumers are spending more than expected, which is key to the recovery trajectory from here, and the shortfall in GDP largely relates to less government spending and re-building of inventories that economists expected between April and June.
Against this market backdrop, how did the Nutmeg fully managed portfolios perform during July?
Given those market moves, July delivered relatively muted returns for fully managed portfolios, ranging from 0.7% in lower risk portfolios, 0.9% in a typical medium risk portfolio and 0.5% in our higher risk portfolios.
Returns in our socially responsible portfolios were slightly lower than that in July – around 0.5% in low risk, 0.7% in medium risk and 0.4% in higher risk.
Given everything that’s happened lately, have you made any changes to the Nutmeg fully managed portfolios?
Last month we mentioned that we started to rebalance our Japanese exposure, and we’ve continued to do that this month as the market has once again underperformed global peers.
This month’s customer question has come from Olly via our client services team. Olly has asked: “Do you have a view on the current rumours in the market that many leading equities are overvalued and there could be an equity bubble that will burst at some point?”
Valuation is certainly top of mind for many investors but firstly, we don’t believe there is currently an equity bubble, or at least not on a broad basis. There will of course always be pockets of typically niche companies that may display bubble like behaviours, but our portfolios are built to be diversified across global stock markets, and therefore thousands of underlying securities.
When we look at valuation, we apply a historical lens, and typical measures of valuation such as price earnings ratios are currently elevated relative to history. But we must also remember the composition of the market has changed as well – in the US for example, technology related companies with strong growth attributes now account for a higher portion of the marketplace, and that pushes up overall valuations in that market. Equally, just because a market is cheap doesn’t mean it will outperform – the UK equity market is a good example of this in the past 18 months. So, we must be very careful with valuation metrics to ensure we recognise their flaws as well as benefits, and how they relate to what’s happening in the wider economy.
And therefore, it’s also worth remembering that valuation is a relative concept as well as an absolute one. That is that investors have to place valuations for stocks in the context of valuations for other investment assets and current market dynamics. Government bonds currently offer negative real (or after inflation) returns, corporate bond markets are offering little by historical standards in terms of additional return for the risks taken, and cash rates are anchored towards zero. Investors are therefore looking to equities as a better risk reward asset, given their potential to benefit from economic recovery and but also as inflation remains elevated.
The Nutmeg Investor Update is now available as a podcast, listen to this month’s update below.
About this update: This update was filmed on 03 August 2021. All figures, unless otherwise stated, relate to the month of July 2021. Source: MacroBond, Nutmeg and Bloomberg.
Risk warning: As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past or future performance indicators are not a reliable indicator of future performance.