The third quarter of 2021 brought supply chain issues, energy shortages, Chinese regulations and other issues for investors to juggle, setting up for a potentially volatile end of the year.
In the three months between July and September, several major market and macroeconomic events took place – the biggest being the energy crisis and global supply chain issues.
The UK’s wholesale energy markets hit record highs in the quarter, stemming from a global surge in demands for gas following 2020’s cold winter which left storage facilities depleted. This occurred at the same time as a post-lockdown energy surge in Asia, creating an urgency to replenish gas supplies before prices skyrocket too far.
Supply chain issues first crept into the picture at the start of lockdown when factories were forced to close and the extended Covid measures only exacerbated the issues.
Andy Merricks, EF 8AM Focussed fund manager, said that we’re only now witnessing the full impact of the global economic lockdown.
“The supply chain issues are not going away quickly. The only thing that appears not to be a shortage of at the moment is shortages,” he said.
“We are only now witnessing what the closure of the global economy during a pandemic means to interlinked societies that have got used to having what they want, when they want it, in a just in time system.”
Performance of major indices in Q3
Source: FE Analytics
Both these events fuelled further inflation concerns, which had been building throughout the year already.
Laith Khalaf, AJ Bell analyst, said the events have “continued to stoke fears that inflation may be anything other than transitory.”
These worries weren’t helped by hawkish comments from the UK and US central banks, increasing expectations of an interest rate rise.
There were other concerns as well, however. China was the source of several issues, for Merricks the most worrying was its political intimidation towards Taiwan.
China’s hostility towards Taiwan is because of the latter’s dominant role in global semiconductor supplies, providing 75% of the world supply and China has aims to usurp it, he said. Semiconductors are an integral part to technology devices and having a strong foothold on this asset is proving very competitive.
Merricks’ biggest concern was the rehetoric from countries in the West, which have said they will step in if China increases its aggression towards Taiwan.
China was also the centre of the Evergrande saga. The company is one of the biggest real estate developers and according to analysts one of the most indebted, owing $300bn (£221bn).
The company also took a hit from the Chinese government’s changing regulations which would limit developers capacity to borrow.
Some called it China’s Lehman moment, although Jason Hollands, managing director of Bestinvest, didn’t think it was that dangerous.
But the episode has undoubtedly renewed focus on the fragilities of China’s economic model, Hollands said.
This all occurred with a backdrop of rising Covis-19 Delta cases in the US and Asia, reminding the world just how fragile this year’s growth and recovery remains.
The majority of these issues are expected to continue in the final quarter of the year and in some cases worsen, meaning that 2021 is likely to have a volatile ending.
Inflation remains a “big risk stalking markets,” Khalaf said. Already inflation concerns led to a sharp sell-off in bonds and technology stocks earlier this year.
Merricks, who has been a proponent of inflation as a transitory event for some time, said he has “begun to doubt my own opinion somewhat,” after the oil price was forecast to rise to between $125 and $140 a barrel by the end of the year.
“Transitory, to my mind, wasn’t supposed to last well into next year,” he said.
“There is disruption pretty well everywhere at the moment and our local binmen going on strike is unlikely to be the last bit of unrest we will witness as the nights draw in and the days get shorter.”
Hollands however thinks that inflation will peak in 2021’s final quarter, but the economic recovery from Covid will be bumpier from here. “I think the fourth quarter could be quite a volatile period for markets,” he said.
Alongside inflation, markets will be heavily focused on central banks and in particular their messaging around ending quantitative easing (QE) programmes.
The US Federal Reserve is expected to announce a tapering of its QE programme in November, ending more than a decade of ultra-loose policy. Markets are unlikely to take too kindly to this policy shift, Khalaf said, and investors should expect interest rates to rise as a result.
However this will benefit equites long-term making them “better placed to deal with a rising rate environment than bonds,” the analyst added.
For the UK in particular the final three months of the year “could be critical” after growth stalled over the summer and the UK market and economy are now contending with inflation and increasing taxes, Yearsley said.
“We could be in for a tricky period with consumer and business confidence stalling.”
Overriding all of this is the threat of the pandemic throwing “another curve ball,” Khalaf said.
“Vaccines seem to be doing their job, but if the past 18 months have told us anything, it’s not to be complacent about the capabilities of the virus.”