As global economic growth appears to have slowed in the third quarter, international equity markets ended the quarter down some 2.58% over the three months through September 24th, as measured by the iShares MSCI ACWI ex US ETF, ACWX.
Economic growth and equity market performance at the country level varied widely, with flareups of the Delta variant of COVID, progress in vaccination, supply-chain bottlenecks, and developments in China being the main factors. While manufacturing clearly is softening after strong performance in the first half, the global economic recovery remains solid according to the recent OECD Interim Economic Outlook. Growth was particularly strong in the second quarter in countries where vaccination rates were high, COVID containment measures were able to be reduced, or infection rates were low. High fiscal support and buoyant consumer spending contributed to the second quarter’s growth. The spread of the Delta variant hindered economic activity in the third quarter, particularly in countries with low vaccination rates in Asia, Latin America, and Africa.
Developments in China have had significant negative effects on equity markets thus far this year. The rapid pace of the Chinese economy early in the year slowed in the third quarter, significantly affecting countries with a large Chinese share of exports relative to GDP, for example, South Korea. Consumption in China was hit by continuing COVID problems, including outbreaks in July and August, leading to restrictions that worsened supply and shipping bottlenecks. Equity markets were hit with a series of sharp regulatory blows affecting internet and other technology firms. The future of Chinese company listings in the US has become uncertain due to actions by both China and the US. In addition, the large property developer Evergrande’s worsening financial difficulties in September focused international investor attention on the excessive leverage in China’s property sector. All these developments have negatively impacted Chinese equities in the third quarter. The total-market iShares MSCI China ETF, MCHI, was down 19.8% over the three months through September 24th.
The strong recovery in Europe’s economies is expected to continue, despite the disappointing September flash composite (manufacturing plus services) PMI for the Eurozone, which fell to a five-month low. It looks as though supply bottlenecks will be a continuing headwind. Pent-up consumer demand should continue to support above-average growth in the coming quarters. COVID developments are always difficult to forecast, but vaccination progress is encouraging. In Spain 80% of the population has received a first shot, 74% in France and Italy, 71% in the UK, and 67% in Germany, all of which are better than the 63% in the US. COVID case growth has declined in all of those economies. Most European equity markets finished the quarter with little change, with the STOXX Europe 600 up just 1.24%. Strengthening earnings reports bode well for the final quarter.
Japan’s stocks also are benefiting from good earnings reports and are trading at a lower P/E multiple than the S&P 500 is. In addition, investors are being assured that the upcoming selection of a new prime minister is unlikely to result in any change in economic or monetary policies. While vaccinations got off to a slow start in Japan, and some restrictions still are in effect, 68% of the population has now received a first shot. Japanese equities outperformed in the third quarter, with the Nikkei 225 Index gaining 4.1%.
Emerging-market economies other than China continue to be hit by COVID, particularly the Delta variant, as vaccination rates in many countries are too low, with weak public health systems and inadequate social safety nets. Other important negative factors are the slowdown in China and the effects of supply chain disruptions and port congestion. Many emerging-market economies have the potential to accelerate in the coming months if vaccination programs continue to progress, the global economic recovery continues, and supply chain problems lessen. But downside risks remain large, and these may account for the third-quarter equity market’s weakness. Earnings per share momentum stalled, and investment flows continued to be tepid. In the quarter, the iShares MSCI Emerging Market ex China ETF, EMXC, lost 1.6%. Emerging-market stocks are now relatively inexpensive, and some may well be ready to register stronger performance in the coming months. Close monitoring of developments remains critical.
Of the three ETFs mentioned in this note, Cumberland Advisors currently holds ACWX and MCHI in its investment portfolios. The writer does not hold any of these ETFs in his personal accounts.
Chief Global Economist
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