Have we passed the peak of supply disruption?
Posted 15 October 2021
Last week we noted that October had picked up for investors where September had left off, namely equities slowly climbing down from the heights gained over the summer. As petrol availability returned even to London’s suburbs and temperatures outside rose again, so it seemed did global stock markets. Despite broader UK news flow still very much on the gloomy side, stock markets around the world turned positive for October, and drove diversified investment portfolios back above where they had started the month.
This begs the question: are we already past the point of peak supply chain disruption, or have market participants spotted other developments on the horizon that make them more comfortable with what looks like being a largely disappointing end to the year? On the first point, it is a possibility, but not a certainty, and with UK retail trade representatives whipping up fears over no toys for Christmas, there is clearly a chance that the UK at least will work itself into another period of panic buying.
The more important points in our view, however, are around China, and the first Q3 corporate earnings reports coming out of the US. Regarding China, there have been persistent fears that its political leadership was failing to grasp the seriousness of the threat on domestic financial stability from property developer Evergrande going under, and a wider slowing of the economy because of increasingly frequent power cuts. On both issues we saw the type of decisive action in the past week that investors have come to expect from Chinese policymakers over the past decade.
First, the electricity price cap was removed for all heavy industrial users, like aluminium smelters and steel mills, which is expected to ease the China-specific energy crisis at the expense of those heavy industries. This is seen as a much lower price to the economy overall than the damage sudden power cuts inflict on all businesses. Second, Beijing delivered a very decisive acknowledgment of the risk arising from the financial troubles of Evergrande, while at the same time stating that the situation was “controllable” and contagion “unlikely to spread”. Following the heavy sell-off in the Chinese sub-investment grade bond market on Monday, this could become the ‘do-whatever-it-takes’ moment for this testing episode in the Chinese financial sector. We discuss China’s likely contribution to global growth in a separate article this week.
On the side of corporate earnings, some very strong results reminded investors that gradually rising yields are indeed quite beneficial to some sectors, even if they tend to affect overall equity valuations negatively. While corporate earnings reports are by their very nature a look into the ‘rear view mirror’ of economic development, the growth in earnings nevertheless cheered up investors, and contributed to the partial shift in sentiment to the positive. To be frank, the issues and concerns of the past weeks around a slowing of the economy on the back of the supply chain constraints have not suddenly disappeared, but it does seem that more market participants are coming around to accepting that while the next few months are likely to bear earnings disappointments, the overall cycle remains on track for more expansion through 2022.
That does not mean to say it will be plain sailing in markets from here to the end of the year. Of course, short-term sell-offs on specific bad news (like unwelcome central bank statements) remain a distinct possibility. In terms of general market sentiment though, it does feel as if a page has been turned and markets are once again looking further ahead, with a degree of optimism.