The third quarter in full details

Chief Investment Officer's team
24 October 2021
The third quarter in full details
Last week was positive on global markets, led by risk assets

AT A GLANCE

  • Last week was positive on global markets, led by risk assets
  • The week ahead is all about Q3 GDP and corporate earnings reports
  • Softness should be confirmed, but green shoots for Q4 could also appear.

Last week was relatively positive for financial markets, led by risk assets. Stocks were up +1.4% in developed markets and +0.7% in emerging ones, with a welcomed rebound from China after Evergrande paid a coupon on a bond. The early days of the Q3 earnings season were overall good with a large majority of companies beating EPS forecasts. Interest rates were modestly firmer, weighing on the fixed income asset class. The US 10-year yield ended the week at 1.63% after having almost touched the 1.7% mark on Thursday.

With regards to top-down data, last week started with a disappointing Q3 GDP report from China, growing by only +4.9% year-on-year. We will get numbers from major economies in the coming days, which should confirm the softness of the summer, with the Eurozone being the positive exception. Having said that, flash PMI numbers are not bad for October, and we tend to believe that Q4 should be better, opening the door for a more balanced 2022 with continuously improved control over the virus, and hopefully supply chain bottlenecks starting to abate. This view seems to be shared by Jerome Powell who confirmed an imminent tapering of asset purchases and patience on inflation.

The focus next week will however be on the bottom-up drivers. Almost half of US listed companies and one third of European ones will report their Q3 earnings. Both numbers and guidance will matter, especially with regards to supply chains and costs. We are also relatively confident as we believe that the benefits of strong top-down growth should greatly help margins. Our scenario for the end of the year is that growth should come back on a sustainable track, unlocking the modest but still positive upside potential on risk assets. Stay safe.

Cross-asset Update

After a long period of denial Fed chair Powell has thrown in the towel and shifted the inflation narrative from ‘transitory’ to likely to last ‘well into next year’, admitting ‘risks to long and more persistent bottlenecks’ during a virtual panel Friday. He sees the need for tapering, yet by no means for higher rates any time soon. Views are split on whether the Fed is already late on that, and hence will need to slam on the breaks harder once reality dawns, or inflation will rather moderate just in time for Powell to stay put after the end of tapering and be able to bide time with the next move. For now markets are starting to discount a policy mistake, as expectations for rate hikes are being pulled forward to the second half of 2022 alongside rising 2- year yields, even as inflation is rampant, market implied inflation is at the highs of the year, and yet the longerend of the curve is flattening. The shorter-end is telling us that price pressures will run for a while, but the longer-end that the Fed won’t tolerate that for much long. The market is not necessarily right and can meantime change its view, which currently ties in with the fact that for the first time in many decades we are confronted with a supply problem, not enough of supply due to bottlenecks on many fronts, not so much a demand problem. And central banks are ill-equipped to tackle supply-related issues, hence they might in the end be reluctantly pushed to do something thinking that things could otherwise get out of hand.

Inflationary issues won’t go away any time soon. Most commodity markets are tight and will remain tight into 2022 according to some major studies, with the most likely beneficiaries being copper and oil. The latter feeds straight into inflation expectations, as the correlation between market-implied inflation and crude returns has always been very tight. Oil and base metals inventories are projected to be significantly lower by year-end, and the persistent energy crisis in Europe should continue to drive gas substitution for oil. Green policies seem now to have been clumsily orchestrated, as oil investments are running at net-zero, “while at the same time demand is not following the net-zero trajectory”, as remarked by an oil strategist in a major investment bank.

The conclusion is that, apart from more near-term upside for commodities, long dated Treasury yields have still room to rise, cyclical stocks should continue to outperform, and the equity-bond correlation would be staying in positive territory, reducing bond diversification benefits unless price pressures subside. What about gold, if inflation lingers at multi-year highs still for some time? As long as inflation stems from supply-side issues, real rates should fail to rise, and actually could drop further, with market-implied inflation creeping higher faster than nominal rates. Under these conditions gold prices would again find reason to surge. Of course, the Fed should also avoid hiking policy rates in 2022. So, the combination of a policy mistake amidst persistent bottleneck-related inflation would be sending gold through the roof, until the Fed slamming hard on the brakes would have it come back down to earth, maybe crashing.



Fixed Income Update

Last week inflation expectations reached multi-decade highs, and as a result, traders started bringing forward the Fed’s rate hike timelines with one rate hike fully priced in by July 2022. As a result, the treasury yield curve flattened with front-end 3-year yields increasing by 7.5 bps. The front-end continued to trade soft as a rate hike premium rebuilt after Fed Chair Jerome Powell said the central bank would raise rates if it sees serious risks of higher inflation expectations. The benchmark US 10-year yields traded between 1.6% - 1.7% bumping against the highs of 2021. An interesting analysis by Bloomberg puts the total losses at $2.7 trillion if yields increase by 50 bps from here to reach 2019 average of 2.14%. It could bring back the memories of significant losses in 1994 to bond market veterans when the Fed doubled the short-term rates between 1994 and 1995. While we don't see the number being reached this year, next year could be another story. Consequently, we continue to be cautious on long-duration assets.

The US Treasuries and Emerging market Corps were the worst performers last week, while China IG and Asia HY ruled the returns table. In a positive development for Asia HY, Evergrande seems to have found "some cash under the sofa" to pay back its dollar bondholders days before the expiry of the 30-day grace period and thereby avoiding a technical default. As a result, highyield dollar notes from China gained about 4.5% last week after a jump on Friday, putting them on track for the biggest weekly gain since 2012. This has also boosted the funding markets as the Chinese HY issuers rushed into the primary debt market this week to sell nearly $16 billion of new dollar bonds taking advantage of the relatively positive mood among investors. However, this does not signal an all-clear for the asset class. In a significant development, the deal to sell its Property Management arm to Hopson's fell through. Hence, the liquidity stress remains elevated for the company. Moreover, there is a slew of coupon payments and bond maturities due for some weaker entities until the end of November.

GCC markets outperformed the broader Emerging Market last week, driven by a solid performance from HY sovereign bonds' front-end. Both Oman and Egypt continue to trade strongly as the market reprices the country risks on the backdrop of high oil prices and renewed comfort on the credit risks of Asia HY. Turkey bonds remain soft against the backdrop of unconventional monetary policy while inflation is stubborn. The dollar touched a record high against the Lira after the central bank exceeded all dovish expectations with a 200 bps rate cut last week. Similar policy mistakes have always resulted in a weak Lira, which won't be any different this time. Emerging Market investors would be expecting more macro imbalances, constraining the returns of Turkey Sovereigns in the near future.



Equity Update

Despite inflation concerns dominating market talk, sentiment was boosted by travel restrictions continuing to ease and global stocks had a third weekly advance +1.3%, a broad rally across DM and EM, though slightly better for DM equities. Strong 3Q earning releases from Europe and the US led to their outperformance with S&P 500 October to date gains at 5.5% and the Eurostoxx 600 at 4.4%. Our higher overweight on DM is paying off but post earning season, we need to identify the next catalyst. We see EM as mid to long term growth leaders but remain tactically neutral EM Asia. China shares gained almost 4% last week as Evergrande Group default fears subsided, easing concerns about a near term contagion for property developers. However, property taxes are being tested and could take a further toll on the beleaguered property sector, with stricter credit controls and off plan sales at a standstill. US China relations remain fragile as US intelligence warns companies over links with China businesses in AI, Quantum computing, biotech, semis and autonomous systems, on worries about U.S. data compromise.

UAE equities retain their leadership with another strong week of returns, with the Dubai Index +2.4% and the Abu Dhabi Index +0.8% last week. New capital raisings are broadening the market. Fertiglobe’s IPO is set to price at the top end of the range, raising $830 mn in what will be Abu Dhabi’s third-largest listing.

The 10-year U.S. Treasury yield ended the week at 1.63%, and along with Fed Chair Powell’s comments on persistently high inflation, though distinguishing between tapering and tightening guidelines, led to tech stocks not having a good end to what was otherwise an upbeat week. Also, not helping was a warning on ad revenue guidance from Snap feeling the brunt of Apple iOS privacy controls. This also affected social media peers Facebook, Alphabet, Pinterest and Twitter.

Q3 earnings season has about 23% of S&P 500 companies having reported thus far, with sales growth 15% higher y/y and earnings up 33%. The consensus is for earnings growth of 22% for Q4 and 44% for the full year. Consumer companies Unilever in Europe and P&G in the U.S. beat estimates, but spoke of raising product prices as costs rise. After earnings, we think central bank policy shift is the most important catalyst with longer term effects on margins. Supply chain bottlenecks, surging energy prices and rising labour wages, whilst key concerns for companies and much touted in their guidance, should eventually ease. In Europe the auto makers are seeing a chip shortage affect production in contrast to U.S. based Tesla which had a great quarter and is now the 6th largest company by market cap in the S&P 500. Worries that Q3 S&P 500 EPS would be below Q2 seems unfounded as corporate margins are retained above 12%. Netflix reported a stellar quarter helped by Squid Game and added 4.4 mn subscribers. So far the Q3 reporting has been largely dominated by financials and big tech earning/ guidance is set to direct markets this week.

We remain constructive on further gains from equities, with the higher DM valuations mitigated by strong earnings growth.



Written by:

IMPORTANT INFORMATION

This document is prepared by Emirates NBD Bank (P.J.S.C) (“the Bank” or “Emirates NBD”), licensed and regulated by the Central Bank of the UAE (“Central Bank”) and the Securities and Commodities Authority of the UAE (“SCA”) and subject to regulation, supervision and control of the Central Bank and SCA, having its head office at Baniyas Road, Deira, PO Box 777, Dubai, United Arab Emirates. This document may be distributed and/or made available by the Bank and its affiliates and subsidiaries, including Emirates NBD Capital KSA CJSC (“ENBD Capital”) (through its website, its branches or through any other modes, whether electronically or otherwise).

Emirates NBD and its affiliates, subsidiaries and group entities, including its shareholders, directors, officers, employees and agents are collectively referred to Emirates NBD Group.

Any person (hereinafter referred to as “you”, “your”) who has received this document or have access to this document shall acknowledge and agree to the following terms.

Reliance

Data/information provided in this document are intended solely for information or illustrative purposes and are not designed to initiate or conclude any transaction.

This publication may include data/information taken from stock exchanges or other third-party sources from around the world, which Emirates NBD reasonably believes to be reliable, fair and not misleading, but which have not been independently verified. The provision of certain data/information in this publication may be subject to the terms and conditions of other agreements to which Emirates NBD is a party. Opinions, estimates and expressions of judgment are those of the writer and are subject to change without notice. Emirates NBD or any member of Emirates NBD Group makes no representation or warranty and accepts no responsibility or liability for the sequence, accuracy, completeness or timeliness of the information or opinions contained in this publication. Nothing contained in this publication shall be construed as an assurance by Emirates NBD that you may rely upon or act on any information or data provided herein, without further independent verification of the same by you.

The contents of this document are prepared as of a particular date and time and will not reflect subsequent changes in the market or changes in any other factors, including those relevant to the determination of whether a particular investment activity is advisable. Emirates NBD does not undertake any obligation to issue any further publications or update the contents of this document. Emirates NBD may also, at its sole discretion, update or change the contents herein without notice. Emirates NBD or any member of Emirates NBD Group does not accepts no responsibility whatsoever for any loss or damage caused by any act or omission by you as a result of the information contained in this publication (including by negligence).

References to any financial instrument or investment product in this document are not intended to imply that an actual trading market exists for such instrument or product. Certain investment products mentioned in this document may not be eligible for sale in some jurisdictions, and they maynot be suitable for all types of investors. The information and opinions contained in this publication is provided for informational purposes only and have not been prepared with any regard to the objectives, financial situation and particular needs of any specific person, wherever situated. If you wish to rely on or use the information contained in this publication, you should carefully consider whether any investment views and investment products mentioned herein are appropriate in view of your investment experience, objectives, financial resources and relevant circumstances. You should also independently verify and check the accuracy, completeness, reliability and suitability of the information and should obtain independent and specific advice from appropriate professional advisers or experts.

Confidentiality

This publication may be provided to you upon request (and not for distribution to the general public), on a confidential basis for informational purposes only, and is not intended for trading purposes or to be passed on or disclosed to any other person and/or to any jurisdiction that would render the distribution illegal.

Solicitation

None of the content in this publication constitutes a solicitation, offer, recommendation or opinion by Emirates NBD to buy, sell or trade in any security or to avail of any service in any jurisdiction. This document is not intended to serve as authoritative legal, tax, accounting, or investment advice regarding any security or investment, including the profitability or suitability thereof and further does not provide any fiduciary or financial advice. This document should also not be used in substitution for the exercise of the prospective investor’s judgment.

Third Party

This publication is not intended for use by, or distribution to, any person or entity in any jurisdiction or country where such use or distribution would be contrary to law or regulation. It is the responsibility of any person in possession of this publication to investigate and observe all applicable laws and regulations of the relevant jurisdiction. This publication may not be conveyed to or used by a third party without the express consent of Emirates NBD or its affiliates, subsidiaries or group entities distributing this document. You should not use the data in this publication in any way to improve the quality of any data sold or contributed by you to any third party.

Liability

Notwithstanding anything to the contrary set forth herein, Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries shall not, directly or indirectly, be liable, in any way, to you or any other person for any: (a) inaccuracies or errors in or omissions from this publication including, but not limited to, quotes and financial data; or (b) loss or damage arising from the use of this publication, including, but not limited to any investment decision occasioned thereby. Under no circumstances, including but not limited to negligence, shall Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries be liable to you for direct, indirect, incidental, consequential, special, punitive, or exemplary damages even if Emirates NBD has been advised specifically of the possibility of such damages, arising from the use of this publication, including but not limited to, loss of revenue, opportunity, or anticipated profits or lost business.

This publication does not provide individually tailored investment advice and is prepared without regard to the individual financial circumstances and objectives of person who receive it. The appropriateness of an investment activity or strategy will depend on the person’s individual circumstances and objectives and these activities may not be suitable for all persons. In addition, before entering into any transaction, prospective investors should: (i) ensure that they fully understand the potential risks and rewards of that transaction; (ii) determine independently whether that transaction is appropriate given an investor’s investment objectives, experience, financial and operational resources, and other relevant circumstances; (iii) understand that any rates of tax and zakat or any relief in relation thereto, as may be referred to in this publication may be subject to change over time; (iv) consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment; (v) understand the nature of the investment and the related contract (and contractual relationship) including, without limitation, the nature and extent of their exposure to risk; and (vi) understand any regulatory requirements and restrictions applicable to the prospective investor

Forward Looking

Past performance is not necessarily a guide to future performance and should not be seen as an indication of future performance of any investment activity. The information contained in this publication does not purport to contain all matters relevant to any particular investment or financial instrument and all statements as to future matters are not guaranteed to be accurate. Certain matters in this publication about the future performance of Emirates NBD or members of its group (the Group), including without limitation, future revenues, earnings, strategies, prospects and all other statements that are not purely historical, constitute “forward-looking statements”. Such forward-looking statements are based on current expectations or beliefs, as well as assumptions about future events, made from information currently available. Forward-looking statements often use words such as “anticipate”, “target”, “expect”, “estimate”, “intend”, “plan”, “goal”, “seek”, “believe”, “will”, “may”, “should”, “would”, “could” or other words of similar meaning. Reliance should not be placed on any such statements in making an investment decision, as forward-looking statements, by their nature, are subject to known and unknown risks and uncertainties that could cause actual results, as well as the Group’s plans and objectives, to differ materially from those expressed or implied in the forward-looking statements. Estimates of future performance are based on assumptions that may not be realized.

Risk

Data included in this publication may rely on models that do not reflect or take into account all potentially significant factors such as market risk, liquidity risk, and credit risk. Emirates NBD may use different models, make valuation adjustments, or use different methodologies when determining prices at which Emirates NBD is willing to trade financial instruments and/or when valuing its own inventory positions for its books and records. The use of this publication is at the sole risk of the investor and this publication, and anything contained herein, is provided "as is" and "as available." Emirates NBD makes no warranty of any kind, express or implied, as to this publication, including, but not limited to, merchantability, non-infringement, title, or fitness for a particular purpose or use.

Investment in financial instruments involves risks and returns may vary. The value of investment products mentioned in this document may neither be capital protected nor guaranteed and the value of the investment product and the income derived therefrom can fall as well as rise and an investormay lose the principal amount invested. Investment products are subject to several risks factors, including without limitation, market risk, high volatility, credit and default risk, illiquidity, currency risk and interest rate risk. It should be noted that the value, price or income of securities denominated in a foreign currency may be adversely affected by changes in the currency rates. It may be difficult for the investor to sell or realise the security and to obtain reliable information about its value or the extent of the risks to which it is exposed. Furthermore, the investor will not have the right to cancel a subscription for securities once such subscription has been made. Prospective investors are hereby informed that the applicable regulations in certain jurisdictions may place certain restrictions on secondary market activities with respect to securities.

Before making an investment, investors should consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment. In receiving this publication, the investor acknowledges it is fully aware that there are risks associated with investment activities. Moreover, the responsibility to obtain and carefully read and understand the content of documents relating to any investment activity described in this publication and to seek separate, independent financial advice if required to assess whether a particular investment activity described herein is suitable, lies exclusively with the investor.

Intellectual property

This publication has been developed, compiled, prepared, revised, selected, and arranged by Emirates NBD and others (including certain other information sources) through the application of methods and standards of judgment developed and applied through the expenditure of substantial time, effort, and money and constitutes valuable intellectual property of Emirates NBD and such others. All present and future rights in and to trade secrets, patents, copyrights, trademarks, service marks, know-how, and other proprietary rights of any type under the laws of any governmental authority, domestic or foreign, shall, as between the investor and Emirates NBD, at all times be and remain the sole and exclusive property of Emirates NBD and/or other lawful parties.

Except as specifically permitted in writing, you should not copy or make any use of the content of this publication or any portion thereof or publish, circulate, reproduce, distribute or offer this publication for sale in whole or in part to any other person over any medium including but not limited to over-the-air television or radio broadcast, a computer network or hyperlink framing on the internet or construct a database of any kind. Except as specifically permitted in writing, you shall not use the intellectual property rights connected with this publication, or the names of any individual participant in, or contributor to, the content of this publication, or any variations or derivatives thereof, for any purpose. This publication is intended solely for non-commercial use and benefit, and not for resale or other transfer or disposition to, or use by or for the benefit of, any other person or entity. By accepting this publication, you agree not to use, transfer, distribute, copy, reproduce, publish, display, modify, create, or dispose of any information contained in this publication in any manner that could compete with the business interests of Emirates NBD. Furthermore, you should not use any of the trademarks, trade names, service marks, copyrights, or logos of Emirates NBD or its subsidiaries in any manner which creates the impression that such items belong to or are associated with you, except as otherwise provided with Emirates NBD’s prior written consent. You shall have no ownership rights in and to any of such items.

IMPORTANT INFORMATION ABOUT UNITED KINGDOM

This publication was prepared by Emirates NBD Bank (P.J.S.C) in the United Arab Emirates. It has been issued and approved for distribution to clients by the London branch of Emirates NBD Bank (P.J.S.C) which is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority in the UK. Some investments and services are not available to clients of the London Branch. Any services provided by Emirates NBD Bank (P.J.S.C) outside the UK will not be regulated by the FCA and you will not receive all the protections afforded to retail customers under the FCA regime, such as the Financial Ombudsman Service and the Financial Services Compensation Scheme. Changes in foreign exchange rates may affect any of the returns or income set out within this publication.

IMPORTANT INFORMATION ABOUT SINGAPORE

This publication was prepared by Emirates NBD Bank (P.J.S.C) in the United Arab Emirates. It has been issued and approved for distribution to clients by the Singapore branch of Emirates NBD Bank (P.J.S.C) which is licensed by the Monetary Authority of Singapore (MAS) and subject to applicable laws (including the Financial Advisers Act (FAA) and the Securities and Futures Act (SFA). Any services provided by Emirates NBD Bank (P.J.S.C) outside Singapore will not be regulated by the MAS or subject to the provisions of the FAA and/or SFA, and you will not receive all the protections afforded to retail customers under the FAA and/or SFA. Changes in foreign exchange rates may affect any of the returns or income set out within this publication. Please contact your Relationship Manager for further details or for clarification of the contents, where appropriate. For contact information, please visit www.emiratesnbd.com.

IMPORTANT INFORMATION ABOUT EMIRATES NBD CAPITAL KSA CJSC

Emirates NBD Capital KSA CJSC (“ENBD Capital”), whose registered office is at P.O. Box 341777, Riyadh 11333, Kingdom of Saudi Arabia, is a Saudi closed joint stock company licensed by the Saudi Arabian Capital Market Authority (“CMA”) under License number 37-07086 dated 29/08/2007G (corresponding to 16/08/1428H) to deliver a full range of quality investment products and related support services to individuals and institutions in the Kingdom of Saudi Arabia. ENBD Capital is subject to Capital Market Law, and Implementing Regulations in the Kingdom of Saudi Arabia

ENBD Capital’s contact details are T +966 (11) 299 3900 and F +966 (11) 299 3955.

This document may not be distributed in the Kingdom of Saudi Arabia except to such persons as are permitted under the Investment Funds Regulations issued by the Capital Market Authority.

The Capital Market Authority does not make any representation as to the accuracy or completeness of this document, and expressly disclaims any liability whatsoever for any loss arising from, or incurred in reliance upon, any part of this document. Prospective subscribers of the securities offered hereby should conduct their own due diligence on the accuracy of the information relating to the securities offered. If you do not understand the contents of this document, you should consult an authorised financial adviser.