Hit the BRICS+

Mark Luschini, Chief Investment Strategist

The BRIC countries, an acronym originally coined in 2001 by Goldman Sachs’ then Chief Economist, stood for Brazil, Russia, India, and China. He identified these emerging market countries as those possessing the potential economic might to surpass that of others, including some developed countries. While that has yet to pass (eventually South Africa was added to expand the term to BRICS), the impulse from these developing markets to contribute more meaningfully to global trade has been nuanced but meaningful.

More recently, however, a deliberate effort has been undertaken to further expand the roster of countries to include the United Arab Emirates (UAE), Iran, Egypt, and Ethiopia, with the possible additions of Saudi Arabia and Argentina. This group is now collectively known as the BRICS+. The “formal” assembly of these countries is indicative of the benefits that have accrued to some of the group’s earliest members from globalization, and a desire to continue the process. In addition, their concern is that the reach for hegemonic status between the great powers of the United States (defending its role) and China (advancing on it), not to mention others that are allying with each predicated upon their national interests, could create blocs that impair their trade and investment options.

Improving Trade Relations

Marginally positive geopolitical developments may emerge from the coalition, but it may produce little in terms of its capability to reduce the conflicts that exist between the U.S. and China, and the European Union and Russia. Afterall, China is aligning in various ways with Russia in an attempt to undermine America’s influence. However, it cannot rely solely on Russia for its economic sustainability, so it is turning to others in the world to augment its economic desires. Meanwhile, other BRICS+ countries are reticent to confront the U.S. or Europe due to their substantial export dependency with each. Instead, they want to remain independent in their relations with the world, particularly with the major developed markets, while collaborating on ways to expand economic cooperation within their emerging market sphere.

This alliance, which was brought into the mainstream via the media attention given to the recent BRICS Summit in Johannesburg, is not intended to be a military grouping, but rather is striving to improve bilateral trade relations and perhaps some increased leverage in negotiations with the West. Furthermore, this group can project to the world a common interest among its members to expand trade and investment with each other, even as there may be some disparate political or military differences. To be sure, it would be Pollyannish to assume all the parties are acting without self-interests, which may lead to instability if relations are ill-formed, such as China’s move on Taiwan, or Iran’s nuclearization efforts unsettling its Gulf Arab rivals.

BRICS+ Moving Forward

There are several reasons why the BRICS+ came together. The first is escalating tensions between the East and West. Given the political divide in the U.S., policy uncertainty is driving other countries to engage with each other for their own vested interests. The second is sputtering growth in China. Many emerging market countries derive a significant amount of their economic vitality through exports to China. Therefore, diversifying their export destinations to other and perhaps faster growing markets, is completely rational. The third is energy supply. Big oil consumers like China and India will want to be engaged in the Middle East to prevent destabilization. Similarly, the Gulf States do not want flows to their largest customers to be disrupted.

The bottom line is that investors should not expect a new BRICS+ revolution to jumpstart an investable opportunity any time in the near future. Indeed, emerging market equities are alluring given the relatively low multiple at which they are trading, and for that reason and more we do believe their secular prospects are bright. However, in the absence of a reacceleration in Chinese growth, and a better overall backdrop for trade than exists currently, a more attractive entry point for shifting risk-based capital to the broad emerging market index may appear in the quarters ahead. Stay tuned.

The Small Matter of Supply

Guy LeBas, Chief Fixed Income Strategist

Does bond market supply matter? The investment community has broadly failed to come to consensus on the question. On one hand, the laws of supply and demand suggest that, as supply increases, prices need to fall (and interest rates rise) to entice demand to absorb the added supply. On the other hand, demand for high grade dollar-denominated bonds seems endless, and the correlation between pricing and supply has been historically poor. More likely is that supply matters sometimes, and this moment in financial history seems to be one of those times.

Chart 1: U.S. Bond Market Composition (2Q 2023)

On August 1, Fitch downgraded the U.S.’s credit rating to AA+ from AAA. While the ratings agency cited political dysfunction surrounding the debt ceiling as a contributing cause, the ratings analysts also highlighted the U.S.’s fiscal situation. The annual budget deficit has settled into a pattern somewhere in the -7% of GDP range, up from the -4% range in the five years leading up to the pandemic. Reasonable people can argue whether today’s economic situation justifies the wider deficit, but one thing is clear: a bigger borrowing need means more Treasury issuance— about $2 trillion of gross sales in 2024. Since Treasuries are about 44% of the $56 trillion of dollar-denominated debt in the world, more Treasury issuance represents a substantial increase in supply.

In 2020 and 2021, Treasury supply was basically irrelevant. The U.S. Government increased debt by 35% during the pandemic years. Average yields on that debt fell, with the Treasury selling 30-year bonds at an average cost of less than 2% during that period. In 2023, however, the markets seem to be having trouble digesting higher debt loads. Each quarter, the U.S. Treasury Department announces (the “Quarterly Refunding Announcement”) how much debt it plans to issue and how it will spread that debt across the various short-term bill, intermediate-term note, and long-term bond sales scheduled for the quarter. In August 2023, the Treasury increased its scheduled coupon sales.

Table 1: Treasury Auction Sizes Increased in August

Market response has been, shall we say, less-thanenthusiastic. The challenge is not just the greater size of auctions, but the larger increase in long duration (7yr+) auctions, which require buyers to accept more interest rate risk. While buyers had no problem absorbing the quantity of supply, they demanded significantly higher yields, triggering a sharp decline in price and an increase in yields through mid-August. Yields rose even relative to other less supply-sensitive benchmarks, as the below chart highlights.

Chart 2: U.S. Yield Curve Is Deeply Inverted

As our simple comparison notes, sometimes supply affects interest rates and sometimes it does not. In 2023, it seems that supply is very much a concern, and given that the increased supply comes on gradually, there are decent odds that we will see similar yield indigestion ahead of other Treasury auctions in the next few months. It is very hard to imagine that the bond markets priced in a full year’s worth of forward supply in just two weeks. And in the absence of economic weakness, there remains upside risk for longer-term Treasury yields until the markets can come to grips with a wider budget deficit over the coming 12 months.

The Final Third

Gregory M. Drahuschak, Market Strategist

Thanks to several history-making declines, some investors think October is the most worrisome month for stocks. History, however, suggests they instead should be more concerned with September.

Chart 3: Average Monthly Percentage Results S&P 500 1950 – 2023

Since 1949, the S&P 500 has ended lower in 59.3% of all Septembers and produced an average 0.70% loss. When the S&P 500 ended September lower, the loss was 3.63%.

From 2000 through 2023, the S&P 500 posted an average loss of 1.62% in September. The average loss in September from 2010 through last year was 0.92%, but the S&P 500 was down in two-thirds of the Septembers. Since 1928, the market was down an average of 1.1% in September. Its best gain of 8.8% was in September 2010. The worst drop of 11.9% came in 1974.

Table 2: Ten Best and Worst Septembers Percent Change in S&P 500

Regardless of the outcome, increased volatility has characterized many Septembers. The S&P 500 has ended the month with a gain or loss greater than 2% in 66% of all Septembers from 1950 to 2022. It is also common for an S&P 500 loss in August to lead to a down September.

However, on a year-to-date basis, when the S&P 500 was up 10% or more by the end of August, the S&P averaged a 0.44% gain in September and posted positive results for the month in 59% of all years.

Table 3: S&P 500 Results

It is difficult to assign a single reason for the market’s weakness in September. One of the most plausible is the end of mutual fund fiscal years and the often-associated tax selling. Regardless of the reason that might prompt market weakness in September, it is not unusual for weakness in September to lead to much better results in October.

Labor Day weekend marks the unofficial end of the summer vacation season and the start of the conference period. Interest in economic and earnings issues intensifies.

After lackluster results through the early part of 2023, earnings estimates for the S&P 500 began rising in July. By the end of August, earnings expectations for 2024 reached $246.12, roughly 12% above what is expected for 2023. Nonetheless, this still left the S&P 500 at a relatively liberal 18 times earnings.

The next earnings report period is not due until mid- October, but this month numerous firms are likely to offer some guidance as to their potential third quarter results. The upward earnings momentum from August needs to continue for the market to extend its advance.

Jerome Powell’s Jackson Hole Symposium presentation did not offer much that the market did not already know, but that does not mean that the market put concern about credit policy aside. The final paragraph of Powell’s speech made what we think was a clear indication of what he wants to do with credit. He said, “Restoring price stability is essential to achieving both sides of our dual mandate. We will need price stability to achieve a sustained period of strong labor market conditions that benefit all. We will keep at it until the job is done.”

The biggest risk in September might be the potential for profit-taking in recent market leadership stocks. Substantial outperformance by the Communication Services, Technology, and Discretionary sectors leaves them vulnerable to an interim pullback. Also, it is worth remembering that after Labor Day, there are only 12 legislative sessions before government funding expires, which might lead to another shutdown impasse.

It is difficult to find specific reasons for September’s often weaker-than-average market performance, but the data makes it clear that in many years being somewhat more cautious in September is wise.

At the same time, keep in mind that September often sets the stage for the market’s seasonally best period.