September Rewind: Risk Markets Sell-off on Bond Term Premia Reset

Dr. Carlos Asilis, Chief Investment Officer, Glovista Investments
Darshan Bhatt, CFA, Deputy Chief Investment Officer, Glovista Investments
October 9, 2023

Global risk indices posted considerable price declines in September.

We believe the September sell-off in risk indices is due to fundamental and technical factors including:

  • Higher sovereign bond yield levels, fueled primarily by a reset in bond term premium to higher levels. We credit such a dynamic, which has unfolded particularly since the end of July, to a number of factors, including the Federal Reserve’s (Fed) resumption of quantitative tightening stance following a pause owing to adverse developments in the regional banking sector, investors’ increased preoccupation with unsustainably high US budget deficit levels, Bank of Japan’s guidance of an impending end to its yield curve control (YCC) regime and recent acceleration of large Treasury auctions and corporate bond issuance levels.
  • Higher energy prices: Benchmark (Brent and WTI) crude prices have spiked by close to 40% since early July. Such price dynamics have been materially impacted by increased supply-side discipline (production cuts) sponsored by OPEC+, including active participation by Russia and Saudi Arabia.
  • Hawkish rate guidance by the US Federal Reserve: At its most recent September 20th meeting, although the Federal Reserve chose not to raise its Fed Funds reference rate, it adjusted its “dot plots” with an update to its summary of economic projections. In that vein, the Fed signaled a “higher for longer” policy rate stance via a smaller number of rate cuts likely to unfold in 2024.

Source: Glovista calculations

  • Weakening growth in service sector activity: Over the past few weeks, a large cross-section of economies have posted larger downside surprises to service sector activity readings than for goods sector indices. The service sector’s dominant share of the global economy suggests such deceleration of economic activity is likely to translate into downward revenue and earnings surprises over the coming months, particularly at a juncture in which energy prices and debt cost of capital have also mounted higher.

The above-mentioned dynamics have combined to exert downward pressure on asset prices via the valuation compression effects set off by (a) higher term premium levels-driven rise in bond yields; (b) lower earnings growth expectations derived from higher recession risks implied by the deceleration of service sector activity growth, and; (c) pressures on corporate margin and adverse household sector purchasing power effects stemming from higher energy prices and higher debt cost of capital.

We believe in the continuation of defensive portfolio tilts as macro developments appear to be validating our standing baseline case.  Looking ahead, we expect the recent rotation in sector and factor leadership to further extend as corporate profit margins and guidance surprise the downside, particularly in the US. At the top line level, it is important to highlight that while in 2022 revenue growth was cushioned by the strong momentum recorded by nominal US GDP, said dynamic has faded recently as evidenced by a flattish nominal US Gross Domestic Income.

We have highlighted previously the role exerted by (a) some pandemic era-specific transitory policies (both monetary and fiscal) and (b) macro developments (tied partly to disruptions in the supply chain but also the service sector activity explosion that followed the Covid period reopening) in providing a powerful boost to nominal GDP. As we look ahead, we expect a fading of such momentum, in turn, leading to a challenging environment for US corporate top-line growth outlook. On the cost side, the lagged effect of monetary policy (entailing not only the switch from quantitative easing to tightening but also the cumulative rate hikes implemented since early 2022) virtually ensures a considerable tightening of profit margins in the months ahead.

The views expressed are those of Glovista Investments, a boutique manager on the Spouting Rock Asset Management (“SRAM”) platform, as of October 1, 2023, and are not intended as investment advice or recommendation.  For informational purposes only.  Investments are subject to market risk, including the loss of principal.  Past performance does not guarantee future results.  There can be no assurance that any SRAM strategy or investment will achieve its objectives or avoid substantial losses. There can be no assurances that any of the trends described will continue or will not reverse.  Past events and trends do not imply, predict, or guarantee, and are not necessarily indicative of future events or results.  Investors cannot invest directly in an index. 

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