A headwind that we identified in the second quarter did indeed prove to be significant in the third: China’s slowing economy and its impact on the demand for commodities detracted from the performance of the Canadian market and also that of emerging markets. In the case of emerging markets, however, it was above all the surprise regulatory tightening by the Chinese authorities that had the most impact.

Even though the return on bonds was low during the period, we can still find reasons to be pleased. One of the risks was that the inflation data, which continue to inch upward, would trigger panic among investors. Instead, we saw a moderate steepening of the yield curve, which will prove to be profitable over the long term because of higher current yields. 

The market continued to agree with the central banks’ assertion that inflation will be transitory. A common method used to assess whether inflation is likely to become problematic is to compare consumers’ shortand medium-term inflation expectations. The table below shows the changes in this indicator:

As we can see, the uptick in short-term expectations has not yet spread onto a longer-term horizon. We can therefore conclude that the ingredients for a self-sustaining inflationary dynamic are not yet present.

This explains, among other things, why the steepening of the yield curve remains relatively modest and why the central banks are being patient when it comes to monetary tightening.

Although desirable in the long run, the gradual return to higher interest rates is a drag on shorter-term performance. With this in mind, it’s worth remembering that the merits of exposure to a particular asset class aren’t limited to the potential return. Combining weakly correlated assets helps create a better-performing portfolio whose overall volatility is lower than the sum of the volatility of its assets taken separately.

If interest rates continue to rise gradually, the low return on bonds will be offset by a solid stock market performance. The yield curve’s upward trend is desirable because it provides the bond market with the vigour it will need to perform well when the stock markets begin to weaken. The outlook is modest for bonds; but given the difficulty of predicting exactly when the stock market will correct, it’s preferable to maintain some exposure to them.

Changes in the crude oil price in the third quarter

Global equities again recorded results that varied from one region to the next. With the exception of the energy sector, which did very well everywhere, and to a lesser extent the financial sector, Europe again outperformed Asia and emerging markets. Asia came in second but with a negative return. Investors wondering why emerging markets recorded the worst performance should note that China, the epicentre of the problems with its regulatory tightening and the collapse of Evergrande, has a considerable weight² in the emerging index. Moreover, the Evergrande crisis also affected the Brazilian market, given that it is a major supplier of the resources required for property development.

The MSCI Europe Index ended the quarter with a return of 0.8% in Canadian dollars, while the MSCI All Countries Asia Pacific Index returned -2.1% and the MSCI Emerging Markets Index returned -5.9%.

Looking on the positive side, we see that emerging markets and Asia have made a great deal of progress with their vaccination efforts. For example, India can now administer an average of more than seven million injections a day. This increase has reduced the significant gap between these regions and Europe and North America.

Vaccination rates

Moreover, China’s new regulatory measures are not expected to create another dramatic shock wave. The market has largely priced in the repercussions of the government’s objective: to ensure sound and equitable development in the country. Limiting the energy disaster of cryptocurrency mining, addressing the scourge of cyber addiction and ensuring affordable access to education are measures that should pay off in the long run, even if the approach may seem extreme.

The expected catch-up vis-à-vis the developed markets could occur at the end of the year, assuming, of course, that Evergrande’s liquidity problems and overindebtedness do not have a domino effect.

The problems facing Evergrande are a reflection of the structural challenges afflicting the overindebted Chinese economy. The local authorities are aware of the situation and have been struggling for years to resolve it. The Chinese government’s priorities are clear, however, and it has tremendous means of achieving them. The government also guided the direction of the country’s real estate market early in 2016: houses are to be lived in, not used for speculation. It may choose not to rescue the real estate giant, preferring a short-term economic shock to persistent excess corporate debt.

Another potential risk is the appearance of a new variant. At present, the Delta variant is by far the most widespread, and the vaccines currently available are all effective against it. Given the vaccination rate reached in many parts of the world, as well as the countries where it continues to rise, the probability that a new variant will spread to the point of slowing the economy again is therefore rather low.

Percentage of cases caused by the Delta variant

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