July Investment Summary
Well, that was a great year we had last month! Major developed equity markets rallied, in some cases significantly in July, buoyed by what for some was interpreted as a potential ‘pivot’ by the US Federal Reserve – time will tell if June was the bottom for developed market equities.
As we suggested in last month’s letter, it was hard to believe the second-half of the year would be worse than the first. That being said, few, if any, would have expected the Nasdaq finish the month up over 12%, with the S&P 500 right behind rising over 9%. In Europe, the Euro STOXX 50 climbed 4.5% and the FTSE 100 was up 3.5% despite the domestic political drama around the Conservative Party leadership contest. Turning to Asia, whilst the Nikkei 225 had a strong month, rising over 7%, Chinese equities underperformed with the Shanghai Composite Index falling 4.9% and the more domestic focused CSI 300 down 7.6%.
Bear market rallies are hard to predict and as we have just seen can be quite powerful. We can’t point to any particular trigger, but sentiment and positioning was very negative at the end of June and market participants factoring in a potential Federal Reserve (Fed) pivot certainly helped lift risk assets. Given the rise in asset prices, it is likely a lot of trend following funds were forced to cover their short positions as the rally progressed - driving prices higher. The start of the Q2 earnings season has also provided support for equities. Earnings in the US in particular have surprised to the upside, driven by mega-cap technology stocks which are faring a lot better than analysts forecast. However, we would caution that this is likely to compress in Q3 as companies continue to face margin pressure.
Where we think the markets have overacted is in the notion that the Fed is somehow about to pause or scale back their rate hike ambitions. In the most optimistic scenario, the Fed will start cutting rates in 2023! Headline inflation is 9.1% in the US, the unemployment rate is 3.6% and the labour market remains exceptionally tight. Despite two consecutive 75 basis point rate hikes by the Fed, overnight money is only at 2.25%. That is not a level that is going to slow or reverse inflation. The Fed did drop forward guidance which may have prompted some observers to interpret that as a sign that there would no more big hikes are coming. We think that is a mistake. More hikes are coming, and not just from the Fed.
The European Central Bank (ECB) raised rates in July, hiking 50 basis points, which brings rates out of negative territory for the first time since 2014. Inflation in the Eurozone is currently at 8.9%, so they have a way to go for policy rates to make any difference. It’s clear that the ECB is in a tough position, considering Europe’s heavy reliance on Russian energy. The challenge over the coming months is trying to balance the impact of higher energy prices on growth and inflation. Whilst Russia has turned gas supplies to Europe back on, following a period of planned maintenance for the Nord Stream 1 gas pipeline, capacity is only running at 20%. The race is now on for Europe to refill gas storage levels to a minimum storage target of 80% or they could be in for a real winter of discontent given the EU imports over 80% of its gas, with Russia providing around 40% of those imports.
Turning to the UK, the Bank of England (BoE) is also in a challenging position as surging energy prices have had a big impact on inflation and activity. It’s worth noting that the UK imports around 30% of its annual energy requirements, with the weak Pound also creating additional inflationary pressures. Throw into the mix the Conservative Party leadership challenge, following PM Johnson’s resignation, which has been shortlisted to Liz Truss and Rishi Sunak - both of whom have not necessarily proposed coherent and thoughtful economic plans – all adds up to a very difficult path ahead for the BoE’s Monetary Policy Committee. Not to mention inflation sits uncomfortably high at 9.4%. At the time of writing, markets were pricing in a high likelihood of a 50 basis points increase on 4th August.
It shouldn’t take long for markets to realise that the path ahead is one with a steady course of continued interest rate hikes. We are also seeing many signs of activity slowing in the developed world as Purchasing Managers’ Indices head lower and other measures of retail sales and housing have been showing weakness. Corporate earnings will no doubt be affected by this slowing of growth. China is not helping either as the fallout from their housing bubble bursting is expanding and their stop / start Covid-19 lockdown policies continue to impact growth. We would view the recent rally as an opportunity to further rebalance your portfolio to quality and value. Energy firms have posted record earnings despite the recent drop in oil. We still favour this sector as energy tightness is not going away.
Looking ahead we suspect much of last month’s rally will fade away over time as continued rate hikes and softer earnings impact valuations.
About the Author
Jeff brings decades of investment markets experience to his role of Chief Investment Strategist at Oakbridge Wealth. He was one of the founding partners of Rubicon Fund Management LLP and was latterly Head of Investor Relations. Prior to his return to Rubicon he was founder and CIO of Onewall Advisors UK LLP. Before setting up Onewall, Jeff was a Partner and Portfolio Manager at Strategic Fixed Income UK LLP where he was involved in managing strategies in the macro hedge fund and a variety of managed accounts. Earlier in his career he worked for the foreign exchange unit of Salomon Smith Barney (in Singapore) and managed a variety of global fixed income portfolios at Prudential Global Advisors (a unit of The Prudential Insurance Company of America), and as an analyst in the economic research department of the Irving Trust Company in New York City. Jeff holds a BA with High Honours in Economics from Rutgers University and an MBA from New York University’s Stern School of Business Administration.
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