Third Quarter 2021 CIO Review and Outlook

There have been few years where the short-term swings in the markets have been (to my eyes at least) more in conflict with long-term trends: a sell-off in tech sectors and health care, a rise in cyclical businesses as opposed to secular growth, and dramatic rallies favouring one country over another.

For the shorter term, 2021 has seen the long-awaited value rotation. In a disinflationary environment, mega-cap growth stocks tend to do well; when economies reflate and yields rise, these growth stocks have their valuations questioned. Cyclical businesses like banks and materials bounce back. Smaller companies enjoy the more liquid environment—all of these effects have been present this year and we have endeavored to take advantage where we can.

The year has been a good one for India, with the one year performance differential with China reaching 60 percentage points (as of September 30, 2021). Why has India been so strong? Well, it’s partly a recovery in earnings growth from the nadir of the pandemic. However, this is not a sufficient explanation, for earnings-per-share have bounced back to a point that seems to me to be above trend. India has seen strong growth in manufactured exports, notably the automotive sector, as demand has recovered in Southeast Asia and Latin America. Is this cyclical? Or is it the start of a growing manufacturing prowess? If the latter, then the recent rise in valuations is well-deserved. And yet it is impossible to know for sure. One should also note that India’s liquidity environment has been helped by the world’s disinflation and by the swing from current account deficit to surplus, which has also supported the rupee. These are all vulnerable to a more reflationary environment and so some caution is warranted.

Japan had a difficult start to the year but as the reflationary pressures have grown, the market got into its stride a bit more. It has been helped by the global rebuild of inventories, as Japan’s manufacturing bias has supported the rebound in factory production. Ongoing trends of automation to improve factory yields also play to the strengths of many Japanese companies. In light of these current trends, Japanese equities have undemanding valuations.

In the rest of Asia and in the emerging markets, it has been the more cyclical business and economies that have tended to do well. As is often the case, Russia has done well as China has faltered. Latin America has rallied, partly because of raw material price rises but also because of some of the same current account effects that India has enjoyed. It is undeniable, though, that Mexico has done much to bolster their external position within the context of a manageable budget deficit.