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Market Volatility
Recovery’s momentum pauses on uncertainty

China was one of the first nations to effectively control the COVID-19 pandemic, and its efforts helped lead the world out of the resulting economic tailspin. It’s more than a bit ironic, then, that China might also offer the first real test of the global recovery and the standout bull market that sprang from it.


The Chinese government’s recent regulatory crackdown has punished individual companies and battered whole industries. More-stringent rules around housing speculation have slammed deeply leveraged real estate developers, raising fears of a systemic debt unwinding. More broadly, virus-related manufacturing slowdowns in China and elsewhere in Asia could exacerbate inflation because so many goods are manufactured there.


The uncertainty in China was just one of several factors that left U.S. stocks essentially flat in the third quarter. The Delta variant caused some momentum to leak from the economy. Shipping bottlenecks and shortages of goods and workers dragged on longer than expected, as did inflationary pressures. And while the labor market is relatively good considering the depths of last year’s recession, the lingering pain has disproportionately fallen on lower-income workers — a sign of possible weakness that might become more prominent as government stimulus efforts fade.


Beyond the financial realm, the economic apprehension has been spiked with political drama — including the Democrats’ internecine squabbling over President Joe Biden’s economic plans and the congressional clash over the debt ceiling.


However, the malaise of late might signal more of a pause than something worse. Stocks are still strongly positive for the year, with the S&P 500 up nearly 15%. Central banks have signaled that they’re preparing to return to more typical economic support — a sign of faith in underlying conditions. The end of enhanced unemployment benefits could bring a more typical job market. And American consumers remain a bulwark, with household debt at notably low levels and savings at corresponding highs.


Beyond that, the economic harm from each wave of the pandemic appears to be lighter than the last as vaccination efforts proceed — and as governments, businesses and consumers simply learn to coexist with it.


Consumers have been saving more during the pandemic


This chart shows how 10-year Treasury yields rose suddenly at the end of the quarter. While average yields for the quarter were 1.32%, they jumped in the last few days of September, ending at 1.52%. Source: U.S. Treasury Department. As of September 30, 2021.
Source: Federal Reserve Bank of St. Louis. As of October 1, 2021.

China is once again at the forefront of investors’ thoughts.


With a recent uptick in regulatory action and fears of a debt contagion, China has become a source of agita for markets. Many foreign investors have reduced their holdings, dropping their share of Chinese equity ownership to the lowest levels in years.


The regulatory crackdown is a major wild card. The new rules, focused on reducing economic inequality, have had varying impacts across industries. Some have reported little effect while others — such as primary-school tutoring — have effectively been shuttered. Efforts to rein in housing costs have added pressure to indebted real estate developers. Property giant China Evergrande Group missed a bond payment in late September, raising worries that other debt-laden businesses might also fail to meet their obligations.


As one of China’s largest real estate developers, Evergrande poses the most immediate question. Were it to collapse, the effects could reverberate across the economy. More troubling, its model of using extensive debt to fuel what now appears to be unsustainable growth is not unique; many other Chinese development firms took the same route. These poor underlying factors are one reason Capital Group Private Client Services has avoided Evergrande and companies like it.


However, many Capital Group analysts and portfolio managers believe the systemic risk to China’s real estate and bond markets is limited. The government has had ample time to prepare a plan — Evergrande’s weak balance sheet has been an issue for years — and appears willing to act, given that its recent regulatory push specifically sought to rein in housing speculation.


Moreover China is likely to remain a source of promising investment opportunities. Many industries are unlikely to be affected, and several of the dynamics that have long pointed in China’s favor — such as a rapidly growing middle class and strong manufacturing base — are likely to continue driving long-term growth regardless of the regulatory environment.


Bond yields jumped as investors prepared for higher rates and less support.


Bond yields swiftly rose at quarter-end after the Federal Reserve said it could begin tapering its $120 billion in monthly asset purchases as soon as November. The 10-year Treasury yield ended the quarter at 1.52%, significantly higher than the quarter average of 1.32%.


10-year Treasury yields rose at quarter-end


This chart shows the personal savings rate in the U.S. in recent years. Before the pandemic, personal savings rates hovered below 10% for many years. However, during the pandemic, rates soared, peaking above 30% in early 2020. The average savings rate for 2020 through August 2021 was above 15%. Source: Federal Reserve Bank of St. Louis. As of October 1, 2021.
Source: U.S. Treasury Department. As of September 30, 2021.

But while a similar Fed announcement in 2013 set off the semi-famous “taper tantrum,” thus far this one has evoked more of a momentary wince. Though the central bank also said it could begin raising interest rates next year, policymakers had telegraphed their thinking well in advance.


Inflation also weighed on the bond market. The consensus view among Capital Group economists is that heightened inflation is transitory, but they’re mixed on how long it could stay, with estimates ranging from several months to as long as two years. The outlook is complicated by issues with supply chains, particularly in Asia, which can be a significant driver of higher costs.


Regardless of short-term conditions, fixed income plays an essential role in well-balanced portfolios. It can provide income generation and capital preservation, as well as needed diversification from sharp or unexpected moves in stock prices.



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