By Michael Mullaney | Director of Global Markets Research
Published October 2021
Value continues to outperform Growth as investors seek gains amid anticipated geopolitical uncertainty heading into the fourth quarter.
September lived up to its reputation as the cruelest month of the year for stock returns based on data dating back to 1928, as stock prices succumbed to a series of obstacles. News of the Federal Reserve inching closer to tapering their bond purchases, surging energy prices, a failing Chinese property giant, the continued standoff between Democrats and Republicans over the U.S. debt ceiling, inter- and intra-party bickering over the passage of the Biden administration’s $3.5 trillion climate and social stability bill, and the ongoing COVID-19 health crisis all weighed on the markets during the month.
At -4.65%, the S&P 500 posted its worst monthly performance since March 2020, breaking a string of seven straight monthly gains, its longest streak of positive returns since 2017. Despite this weakness, the benchmark was still able to eke out a positive total return for the quarter of +0.58% and remains up +15.91% on a year-to-date basis.
September’s Mixed Signals
Only one sector, Energy (+9.37%), was able to produce a positive rate of return during the month. It was the beneficiary of strengthening demand intersecting – or more aptly colliding with – constrained supply, which translated into price jumps in oil (Brent crude increased by +8.52%; WTI oil by +9.53% and natural gas surged by +25.43%).
At the opposite end of the spectrum was the Materials sector, which dropped by -7.21%. Stocks in this category were hurt by the surge in energy input costs, weakness in China, and a drop in global industrial activity. The so-called bond proxy sectors, Utilities and Real Estate, also suffered during the month as interest rates rose by an average of 14 basis points (or 0.14%) along the coupon-paying portion of the U.S. Treasury yield curve, leading to a loss of -0.97% for the broad U.S. investment-grade bond market. During the month, these sectors fell by -6.18% and -6.23%, respectively.
For the quarter, Financials led all sectors with a gain of +2.74% on the jump in rates which – more often than not – helps to lift insurance and bank profits. Industrials pulled up the rear dropping by -4.22% in response to the so-called “soft-patch” in economic activity. And similar circumstances that fueled Energy shares in September, have also made the made the sector the leader on a year-to-date basis, with a gain of +43.10%. Utilities, meanwhile, are the laggard over the past nine months, with a year-to-date gain of +4.20%.
During September, there were mixed signals as to whether it was a “risk-on” or a “risk-off” trading environment. While “risk-on” seemed to be supported by small-capitalization, high-beta and lower-quality stocks each outperforming their respective large-capitalization, low-beta and higher-quality counterparts, they only did so by losing less. For context, small cap is represented by the Russell 2000 Index, high-beta refers to the highest beta quintile of the S&P 500, and low-quality refers to stocks rated “B” or lower by Standard & Poor’s, while large cap is represented by stocks in the Russell 1000 Index, low beta refers to the lowest beta quintile of the S&P 500 and high-quality refers to stocks rated “B+” or higher by S&P’s.
Part of the dilemma can be explained by the returns generated by the FAANG stocks (Facebook, Amazon, Apple, Netflix and Google) plus Microsoft. These high quality/large-cap stocks are also considered to be “long-duration” in nature given that a considerable portion of their expected cash-flows reside in the distant future, making them more sensitive to changes in interest rates. Collectively, these stocks represent 23.5% of the Index and had an average loss of -5.44% during the month that contributed to over a third of the total loss the S&P 500 suffered during the month. (Netflix, for the record, produced a gain in September, but was the exception among its FAANG peers.) Still, the underperformance of these names is a large part as to why the equal-weighted S&P 500, which neutralizes their Index impact, beat the cap-weighted Index by +84 basis points.
For the quarter and on a year-to-date basis, large-capitalization and high-beta stocks were the winners, while there was a split decision for quality, with high-quality ahead for the quarter, but lower-quality inching past high-quality on a YTD basis.
Given their greater exposure to both the Financial and Energy sectors, Value stocks beat Growth stocks during September by an average of +1.70% across the Russell 1000, Russell Mid-Cap, and Russell 2000 style benchmarks. Value also led Growth during the quarter by an average that exceeds 10% across the three capitalization ranges on a YTD basis.
During September, both developed market international stocks (MSCI EAFE) and emerging market stocks (MSCI EM) generally beat the returns found in the U.S., once again by losing less. In local currency terms, EAFE returned -1.30% during the month while the MSCI EM Index dropped by -2.82%. In U.S. dollar ($US) terms, the returns were lower, with EAFE down by -2.83% and EM dropping by -3.97% as the dollar appreciated by +1.41% against a basket of currencies of advanced foreign economies and by +0.95% versus the MSCI Emerging Markets Currency Index. The $USD gains can be attributed to rising interest rates, the threat of the Fed tapering, and the greenback’s “reserve currency/safe haven” status.
For the quarter and on a year-to-date basis, both developed and emerging market stocks continue to lag those in the U.S. The EAFE Index gained +1.32% over the past quarter and +14.23% YTD in local currency terms and posted a loss of -0.35% and a gain of +8.79% in $USD terms over the respective periods. Emerging market returns, meanwhile, were lower at -6.69% for the quarter and +0.83%, YTD, in local currency terms and -8.09% and -1.25% in U.S. dollar terms, respectively. Emerging market stocks have been hurt by $USD strength, China weakness, isolated surges of inflation, and tepid vaccination progress.
Washington Brinkmanship Has Markets on Edge
The Senate and House of Representatives passed a continuing resolution bill on the last day of the month that allows for the funding of the federal government through December 3rd. The bill effectively “kicks the can down the road” on a potential government shutdown for the next two months.
With that pitfall temporally averted, Washington brinkmanship turned its attention to the U.S. debt ceiling, where every Senate Republican and at least two Democrats are balking at either increasing or suspending the current $28.4 trillion debt limit allowed to the U.S. Treasury. Republicans have stated that they won’t go along with a stand-alone bill to increase the debt ceiling and Democrats are reluctant to add any increase to their $3.5 trillion reconciliation bill that is in the process of being finalized. The last bouts of political infighting over the debt ceiling occurred in 2011 and 2013, and in both instances the ceiling was increased just prior to the government defaulting on its debt. Currently, Treasury Secretary Janet Yellen has indicated that her department will run out of fiscal maneuvers to meet its obligations by October 18th. Given the current level and nature of the rhetoric between the parties, one should expect that any resolution to the impasse will be once again “last minute” and markets to remain “on edge” until such time. To gather the needed votes, President Biden’s $3.5 trillion spending plan is expected to be reduced to a range of $2.0 trillion to $2.5 trillion.
Other global threats also emerged. With a $USD equivalent of $302 billion in liabilities, including some $82 billion of publicly traded debt, the highly levered Chinese property company Evergrande Group has already missed two interest payments during September on its dollar-denominated debt, though the company has a 30-day grace period to resolve the issue before being declared insolvent. While some pundits have deemed this to be the Chinese equivalent of the failure of Lehman Brothers in the U.S. given that the property sector represents some 30% of China’s GDP (more than double the U.S. exposure). (Market watchers will recall that Lehman’s collapse helped to trigger the Great Financial Crisis of 2008). More importantly, Evergrande’s liabilities are “just” 1.8% of China’s GDP whereas Lehman’s liabilities represented 4.1% of U.S. GDP. Given that exposure, most of the potential damage from Evergrande appears to be isolated within China, unless the property problem is determined to be more systemic, and the risk of contagion ignites.
Meanwhile, the current supply/demand imbalance that is found in the Energy sector appears to be more problematic as OPEC and its Russian affiliates have decided not to increase production to take advantage of current prices and have chosen to adhere to their plan of increasing production by just 400,000 barrels per day in monthly installments. Exploration and production of carbon-based energy sources is still impacted by earlier decisions to curtail investment in new reserves during the period of falling energy prices from 2016 to 2018. More recently, pressures from investor groups for companies to move toward carbon-footprint neutrality in the future is also putting a strain on supplies. Those decisions and goals could lead to a longer “transitory” period of higher inflation.
On a more positive note, the third wave of COVID infections and hospitalizations from the Delta variant appears to have peaked and vaccinations across the U.S. are on the rise once again. We will know shortly if the reopening of schools/colleges and falling temperatures trigger another reversal of the positive trends.
Finally, since WWII there have been 27 occurrences of the S&P 500 return exceeding 10% through September. In 22 of those episodes, or 81.5% of the time, the Index went on to post a positive return for the final three months of the year with an average return of nearly 4%.
Boston Partners Global Investors, Inc. (“Boston Partners”) is an investment adviser registered with the SEC under the Investment Advisers Act of 1940. The views expressed in this commentary reflect those of the author as of the date of this commentary. Any such views are subject to change at any time based on market and other conditions and Boston Partners disclaims any responsibility to update such views. Past performance is not an indication of future results. Discussion s of securities, market returns, and trends are not intended to be a forecast of future events or returns.