With the pandemic under control in China, economic activities had gradually resumed, which was reflected by the improving economic data, such as the PMIs’ recovery to or close to the expansion level. With the vaccination rates reaching herd immunity levels, and the government adopting effective countermeasures, it was expected that the country can recover and return to pre-pandemic levels. However, unexpected disruptions to the economic activities due to the abrupt power curbs raised concerns over the economy outlook in China. 

More so, market uncertainties arising from the ongoing debt crisis continue to impact market sentiment. More Mainland developers defaulted on their debt obligations over the month, the debt-ridden Evergrande group is also on the verge of doing so. With liquidity conditions in China being on tight end, if confidence in the property market further weakens, this could lead to a snowballing problem. Henceforth, as uncertainties in the Chinese market outlook remain, this could hurt market sentiment. We would stay neutral on the market in the short term, only staying selectively positive on segments that are structurally integral to the country.

On the economic front, US data is still decent. Key PMI data have all stayed at higher levels, employment data was encouraging, possibly suggesting that the economy has recovered from the COVID pandemic. With the economy back to pre-pandemic levels, the current inflation problem should be the next issue pending resolution. Fed Chairman Jerome Powell’s view on the currently elevated inflation has shifted from ‘transitory’ to ‘could last longer than expected’. This suggests that monetary tightening could be more imminent, so as to counter the higher inflationary pressures as the Q4 energy crisis hits. 

According to the latest Fed Dot Plot, committee members have turned slightly more hawkish, interest rate futures market have also reacted accordingly, currently pricing in one rate hike by the end of 2022. All these point to a tapering announcement as early as November. The expected reduction in market liquidity could put further pressure on the market valuation levels and could result in limited upside for the US equity market in the short term. While we do expect the US market to perform in line with global equities, we would stay on the cautious side for the last quarter of the year as the downside risks do remain. 

 US

High energy prices continued to raise concerns about rising inflation, but the US financial sector Q3 results were promising, easing fears of an economic slowdown, the three major US stock indices rose 1.56% to 1.73% on Thursday alone, reversing the weakness over the past five days. As the US entered the new earnings season, 77% of the latest 35 S&P companies reported market beats, of which 89% of the 9 financial institutions managed to beat the market.

The global energy crisis continued with a surge in energy prices, with WTI futures rising again to US$82.1 per barrel at the time of writing and New York natural gas prices rising again to US$5.77 per MMBtu. In addition to energy, some base metals prices also recovered, with the LME aluminium price rising to US$3,099 per tonne and hitting a 13-year high, the LME metals index also reached a new record high. The Organization of the Petroleum Exporting Countries (OPEC) remained cautious in its oil demand forecasts despite the surge in international oil prices. It has been reported that the US government will meet to discuss how to deal with rising gasoline and natural gas prices.

Against the backdrop of surging energy prices, the US Consumer Price Index rose by 5.4% YoY in September, the highest level since 2008. Amid high inflation, the minutes of the US Federal Reserve's September interest rate meeting indicated that taper of bond purchases was expected to be start in mid-November or mid-December, in line with market expectations. The market will continue to monitor the US financial results, with the latest Fed economic beige book and manufacturing PMI data to be released next week.

Europe

European stock markets rebounded across the board, with the UK, French, and German indices rising between 1.58% and 1.91% over the past 5 days ending Thursday. The PEPP is scheduled to expire in March 2022, but there are divergent views among ECB officials regarding this issue; Francois Villeroy de Galhau, member of the ECB Governing Council and Governor of the Bank of France, said that the central bank should retain the purchasing flexibility of the PEPP instead of increasing the amount of bonds on a fixed basis. Klaas Knot, another member and President of De Nederlandsche Bank, said that inflation in the Eurozone might be higher than expected in the short to medium term, suggested that the ECB should end the PEPP programme in March next year. Next week, the UK will release the consumer price index, and Eurozone will release the Markit PMIs.

China

A-shares were stable while Hong Kong stocks had a strong rebound. The CSI 300 Index was roughly flat for the week. After a two-day trading hiatus due to typhoons and holidays, the Hang Seng Index rebounded 1.48% in a single day and hit a one-month closing high after the market resumed on Friday. Panic in the offshore bond market spreads further as yields on the Bloomberg China Dollar Bond Index rose to 20%, the market is closely watching the latest development. Next week, China will release its Q3 GDP and important data on fixed investment, production and retail sales for September.

 US

The US Senate reached a bipartisan agreement to extend the debt ceiling and the market expects the House to approve the bill. The news was positive and US stocks reversed their short term weakness, in the past 5 days ending Thursday, the Dow, S&P and NASDAQ rose by 2.69%, 2.14% and 1.42% respectively. On the US debt ceiling issue, Senate Republican Leader Mitch McConnell originally declared that he would not work with the Democrats. However, McConnell later proposed the short-term extension of the debt ceiling, which was passed by the Senate. According to the agreement, the US debt ceiling will be raised by US$480 billion, which should be sufficient to meet all payments until 3 December this year, lifting the US debt ceiling crisis for the time being.

Global energy shortages sent energy prices to multi-year highs, with natural gas futures surging by 60% over a two-day period. At the end, Russian President Vladimir Putin, a major natural gas supplier to Europe, said he could help stabilise the global energy market, prompting a fall in natural gas prices. While countries are working to address their energy crisis, OPEC+ announced that it will maintain a 400,000 barrel per day increase in crude oil production in November, which falls short of market expectations; together with the US Department of Energy statement that there are no plans to release strategic oil reserves, sent WTI crude futures to a seven-year high of almost US$80 per barrel.

With energy prices high, the market is wary of inflation risks in the US, plus the faster-than-expected expansion of the service sector in September, indicating strong demand, there is high conviction that the Fed will announce a taper in bond purchases in November. The 10-year yield on US Treasuries rose to nearly 1.6%, the highest since mid-June, reflecting rising inflation expectations and the Fed's expected tapering, as funds flowed out of US Treasuries. Next week, the US will release the minutes of its September interest rate meeting and important data such as the September CPI.

Europe

European equities mirrored the global market recovery, with UK, French and German equities rising between 0.73% and 1.27% over the past five days ending Thursday. According to the minutes of the European Central Bank (ECB) meeting in September, members discussed a larger reduction in the scale of asset purchases, and there were suggestions that the market may be preparing for the end of the pandemic support programme. It was also reported that the ECB was looking at introducing a new bond-buying programme to replace the PEPP, which expires in March next year, to avoid market turbulence that could affect the economic recovery. Next week, the ZEW Economic Sentiment Index for October will be released.

China

Asian stock market sentiment improved, with the Shanghai and Shenzhen stock markets ending in the green after the National Day holiday, the CSI 300 Index rose 1.31% in a single day, and the combined turnover of the two stock exchanges exceeded one trillion RMB again. While Hong Kong equities narrowed their gains on Friday, the market rose for two days in a row, reversing the recent weakness, the HSI rose 1.07% for the week and the Hang Seng Tech Index also rose 1.72% over the same period. During the National Day holidays, the market was concerned about the liquidity of mainland property companies. Following Evergrande's missed bond interest payment, another property company, Fantasia, also failed to pay the principal on its maturing notes, which weighed on the Chinese offshore bond market, driving the Bloomberg Barclays China Dollar Bond Index yield up to 16.9%. Next week, China will release CPI and PPI data for September.

 US

The US equity markets logged in one of the larger single-day declines on Tuesday, as sentiment was hit amid market uncertainties. Over the past 5 days ending Wednesday, the NASDAQ took the largest hit, losing 2.58%, the S&P 500 lost 0.82%, while the Dow managed to hold a 0.39% gain. On the economic front, core durable goods orders missed market estimates, coming in 0.2% versus the 0.5% consensus. Conference Board Consumer Confidence Index also fared worse, as the reading of 109.3 for September is both lower than the estimate and the August figure. Fed Chairman Jerome Powell still insisted the view that inflation should ease eventually, but admits that the current pressures could stay well into 2022.

Treasury Secretary Janet Yellen told the Congress that the Treasury will run out of cash by 18th October if the debt ceiling is not addressed, potentially risking the first US default and causing systematic risk to the global financial system. The House have passed a bill to suspend the US debt ceiling, but it is expected to fail in the Senate. It remains to be seen how the Democrats will try to avoid the possibility of default. Next week, the US will release important data including the ISM non-manufacturing and Markit Services PMIs, non-farm payrolls, and unemployment rate.

Europe

European equities had mixed performance, UK equities edged 0.35% higher over the past 5 days ending Wednesday, while French and German indices lost 0.91-1.15% over the same period. On the economic front, Eurozone unemployment rate in August was 7.5%, meeting market expectations. European Central Bank (ECB) President Christine Lagarde admitted that there are factors that could potentially lead to higher inflation, but the risks remain limited at the moment. ECB Governing Council Member Mário Centeno reiterated the ECB view that the current inflation level is only temporary, emphasising the need to keep favourable financial conditions until the economy is clearly out of the crisis. Next week, Europe will release the Services PMI and retail sales figures for Eurozone, Germany will also release Industrial Production Data for August.

China

With the national day week holidays ahead, the Chinese and Hong Kong stock markets lacked clear direction. The CSI 300 Index was 0.35% higher over the short week, while the Hang Seng Index also managed a 1.59% gain. An abrupt announcement of electricity curbs came out of China during the week, citing electricity shortage in several provinces, hitting industrial hubs in Guangdong and other north eastern provinces, concerns over the potentially lower Chinese industrial production led to a fall in shipping and materials sectors. The Evergrande incident continues to drag on, as the company missed the second offshore bond interest payment. The Group has arranged an around 10 billion CNY stake in Shengjing Bank, but more work is still needed before the Group can meet all outstanding liabilities. Next week, China will release Caixin Services PMI.

Inflation conditions remain elevated, CPI figures in the US stayed above 5%, which is significantly higher than Fed’s target level. The situation in Europe is similar, where inflation measurements reached a near 10 year high. Concerned over possibilities that the situation could impact the future monetary policy, market participants trimmed their positions to reduce duration exposure. However, during the Jackson Hole Symposium in late August, Fed Chairman Jerome Powell has been surprisingly dovish in his speech.

According to Powell, the Fed acknowledged that the current inflation has reached the Fed’s target, but they are still not planning to make any tapering calls within the short term. However, with the bond spreads close to the historic low, we would still avoid holding too much exposure in fixed income assets. If one has to invest in the fixed income spectrum, we would continue to value high yields over investment grades, as the largest source of risk in form of duration tends to be lower in high yields. However, when investing in high yields, bear in mind that the credit quality remain of upmost importance, as the recent defaults and credit warnings in China have shown.

If we would just consider the economic indicators, the Japanese economy still has much room for improvement. Although manufacturing PMI has managed to stay steady and expanding, riding on the recovering global economy, services PMI remained firmly in the contraction zone, which could have been a result of the continued epidemic situation in the Japan; household spending also missed expectations in July, heeding signs that the economy could see further slowdown in the second half of the year. 

However a surprise news did come out lately, as Prime Minister Yoshihide Suga recently announced that he will step down as the party leader. As Mr Suga’s approval rating tanked during his relatively short tenure, markets hoped a new prime minister could bring a breath of fresh air to the leadership. Together with a promising vaccination progress in the country, expectations of getting the pandemic under control could give the much needed boost to the stagnant economy, potentially driving the index higher and play catch-up to other developed markets. Although uncertainties do remain in the short term, a potential upwards drive based on lifted market sentiment is not to be ruled out.
 

The economy in some of the markets continued to bounce back, notably in the ones that did not suffer from the ongoing pandemic, the Indian market among them. However, we remain relatively sceptical over the EM outlook. As repeatedly mentioned, the few factors that contribute to the heightened risk in EM markets, including epidemic control, vaccination progress, inflation threats, and mounting external debt, remained true, which we still believe would undermine the performance of EM equities compared to their DM counterparts.

Although there has been COVID resurgence in some of the DM countries, the improving vaccination progress would likely suppress the further spread. A near ‘herd immunity’ allows economic activities to return to normal, and this exactly is one of the biggest divergences between DM and EM. On contrary, vaccination progress in EM countries remain sluggish, possibly due to supply bottlenecks. The rate hikes by EM central banks so as to counter the heightened inflation also serve as headwinds for equity performance. Although there has been recent EM recovery, we will still prefer DM equities over EM in the medium term..

The COVID situation varied country by country, where some have seemingly peaked, while others are just starting its rise. If the UK experience has taught us anything, the key to dealing with the pandemic lies within a comprehensive vaccination programme. Although cases could still climb, severe cases and hospitalisations would stay at a lower level, henceforth allowing the economy to remain open and running as usual. The situation in Europe is exactly that, as economic fundamentals reflect that the economy has not suffered significantly despite the resurgence, which is positive for the equity market.

Even though the Eurozone CPI has slightly overshot forecasts, given the new ECB inflation target, the current level is still within acceptable bounds, and would not warrant an earlier than expected tapering. As ECB President Christine Lagarde has mentioned, ECB is keen on avoiding premature tightening of the policy, which could otherwise result in detrimental impacts on the economy. Markets expect the Bank to keep interest rates unchanged at the current level for an extended period. Henceforth, with the economic growth outlook steady, a possible further boost from the EU Recovery Fund, and ongoing supportive monetary policies, we remain positive on the European equity market.

Economic fundamentals in China further slipped in August, official services PMI even entered the contractionary zone at 47.5, which was the lowest figure since the pandemic trough back in early 2020. The weaker fundamentals could possibly be primarily attributed to two factors, one of which is the resurgence of COVID in the country. The delta variant prompted drastic lockdown measures from the Chinese authorities to limit the spread, the services sector suffered, but the sector outlook is expected to recover as soon as authorities regain control over the epidemic.

Policy uncertainty is the other likely cause in the weaker economic sentiment. As in the most recent politburo meetings, the idea of ‘shared prosperity’ have been reemphasised. Henceforth, we would stay neutral on the market, although the ongoing policy concerns are unlikely to dissipate in the short to mid-term, it should be balanced by attractive valuations and more stable liquidity conditions in the market. If one were to invest in Chinese equities, investors should stay selective, and focus on segments that are structurally integral for the future transition, such that they will face less policy risk.