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Heading into October, the mood of the market was very cautious. Everyone could recite the fears that would cause an imminent selloff, from earnings misses, to taper plans, to China tensions. But as markets “climbed the wall of worry,” the end result was one of the strongest monthly performances for equities in this post-pandemic rally. Many markets finished October with gains in the range of 5%, regaining all of the lost ground from the September selloff and reaching all-time highs.
The recent earnings season has been an interesting ride, as unlike in recent quarters, there has been a much greater divergence between winners and losers. Companies were able to show dramatically different results depending on their abilities to handle the supply chain issues and pass along cost increases to customers.
Plans to return capital back to shareholders in the form of dividends and buybacks was a welcome theme we have seen amongst some of the winners. The energy sector is a prime example of this trend, as many companies enjoy one of their most historically profitable periods, attracting a new group of investors. However, earnings have come in as expected, albeit with slower overall growth rates, which has brought about a relief rally for investors who had feared the worst.
The gain in asset prices for October wasn’t only in equity markets – crypto assets recovered the momentum they briefly lost this summer. Bitcoin is back over $60,000 on the back of a +40% return in the month, with many predicting $100,000 by year-end. One of the catalysts for this move can be attributed to the launch of a U.S. futures-based ETF, which has brought more investor attention to this emerging asset class. While this isn’t the perfect solution for investors, it did take a positive step to open the sector to a new audience.
How investors should use crypto in a portfolio remains a core question. It’s hard to view it as a store of value given the volatility, and maybe should be looked at more like a momentum-trading instrument, but given its scale and attention, it’s here to stay. New products are being created to take advantage of and profit from its volatility, which in the end could make it more suitable to different mandates and even more investors.
With so many assets moving up rapidly in value, the push for real assets as a hedge remains. Whether crypto has benefitted from this theme or not is still early to tell, but the traditional commodities could be setting up for a multi-year run of price increases. After years of investors ignoring commodity companies, the result is a lack of new projects coming. Without capital flowing to the sector, it has become difficult, if not impossible, to bring on added supply in a timely manner to meet demand. We are seeing this in copper, oil, natural gas, and lumber. There is no quick fix on the horizon, so everyone should be getting ready for this theme to become “the new normal.”
The increase in commodity prices will have an impact on inflation. Whether it’s transitory or not doesn’t really matter, as this impacts all asset classes and the path of fiscal policy around the world. Higher input prices combined with higher wages all increase the pressure on central banks to remove stimulus programs and begin to look at rate hikes. Last month, the Bank of Canada ended its bond buying program – we expect others to do the same in short order. After many years of low and even negative interest rates, it appears the next few years could be the reverse, which will cause shifts from long to short duration in fixed income and towards the cyclicals in equities.
As many begin to think toward 2022, it’s important to not forget about the next two months. Seasonally, November is one of the strongest months of the year, but following such a positive October, we will have to see if this holds.
On a year-to-date basis, many markets are up over 20%, which has made it difficult for many strategies to keep pace with their benchmarks. This can lead to performance pressure that can result in price chasing, making it hard to get too bearish on the market in the short term even at these levels.
However, it is important to note that we remain in the later innings of this bull market, and at some point, the pace of gains will slow. For markets to go up, we need some mix of earnings growth and/or multiple expansion. As central banks change their stance from dovish to hawkish, they become much less market friendly, which could put pressure on multiples, while the recent earnings releases show earnings growth could become more challenging.
Does this mean “buy the dip” is done? Hard to tell, as their remains record amounts of un-risked capital in the market. For now, it looks like the path of least resistance is higher, but there will be bumps along the road and making a shift to prepare for the coming volatility may become the prudent solution.
Greg Taylor, CFA, is the Chief Investment Officer of Purpose Investments Inc.
Notes and disclaimer
© 2021 by Purpose Investments Inc. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared on the “Thoughtful” page of the Purpose Investments’ website. Used with permission.
All data sourced from Bloomberg unless otherwise noted.
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