July Issue 2022
Summary
August is typically a month for holidays, as people make use of the last true summer weeks to prepare for autumn and winter.
Equity Snapshot
| United States | • | US equities surged over July, recording their strongest monthly returns since November 2020. Sentiment was supported by speculation that signs of slowing economic growth would mean the Federal Reserve (Fed) would likely rein in the pace of interest rate hikes later this year. Growth stocks outperformed value shares. Many high-profile tech companies delivered reassuring second-quarter results, which indicated they were faring better than many had feared given the backdrop of higher inflation and rates. |
| • | The Fed raised interest rates by another 75 basis points (bps), its second consecutive increase of that size, taking the federal funds rate to a range of 2.25%-2.5%. The 225-basis-point increase since March has been the fastest pace of rate rises since 1981, and US interest rates are now considered to be around a long-run neutral level, which neither fuels nor restrains economic growth. Fed chair Jay Powell said that he thought a recession was unlikely given the strength in the job market but indicated that it “likely will become appropriate to slow the pace of increases”. He also said “another unusually large rate rise” would be implemented if inflation data warranted a more hawkish approach. | |
| Europe | • | European equities rallied strongly over July (in EUR terms), posting their strongest monthly gains since November 2020, as sentiment was lifted by better-than-expected GDP data for the second quarter. Denmark and Sweden led the advance, with France also posting solid gains, but Italian equities lagged due to the resignation of prime minister Mario Draghi following the unravelling of Italy’s national unity coalition government. EU nations reached broad agreement to reduce gas usage by 15% but Russia cut gas supply through the Nord Steam 1 pipeline to just 20% of capacity, further derailing hopes that Europe could build up gas storage ahead of the winter. |
| • | With inflation hitting 8.9% in July, the European Central Bank (ECB) raised interest rates by 50 basis points to zero, its first rate rise since 2011 and ending eight years of negative borrowing costs. The ECB also announced a new Transmission Protection Instrument, aimed at tackling widening yield spreads for countries most exposed to higher rates. To be eligible, nations need to comply with the EU’s fiscal rules, have a sustainable debt trajectory and honour pledges made to access the EU’s pandemic recovery funds. | |
| Asia | • |
Equity markets in Asia delivered mixed returns in July. On one hand, markets were boosted by hopes that slowing global growth would reduce inflationary pressures and lessen the need for aggressive rate rises; on the other hand, overall regional returns were dampened by declines in China and Hong Kong. The weakness was partly due to regulatory uncertainty among tech companies, a resurgence of COVID-19 cases in several cities, concern over the mortgage suspension in the property sector, and disappointment in the potential GDP growth target this year. Elsewhere, Taiwan and Korea bounced back in July after the weakness in semiconductors last month. Australia equities also rallied. Within ASEAN, Indonesia, Malaysia, Philippines, and Singapore equities advanced over the month, while Thailand declined as the baht slumped to a six-year low. |
| Bond | • | Global bonds rallied strongly over July as growing recessionary fears caused investors to dial back their interest rate expectations. In the US, the 10-year Treasury yield fell below 2.7% for the first time since early-April, while the yield curve between 2-year and 10-year bonds inverted – such an occurrence usually foreshadows a recession. The yield on the 10-year German Bund also declined to a three-month low of around 0.8%. Central banks continued to tighten monetary policies to combat accelerating inflation. The European Central Bank raised rates by 50 basis points (bps) to zero, ending eight years of negative borrowing costs. The US Federal Reserve (Fed) hiked rates by 75 bps, taking them to a range of 2.25% to 2.5%. Japan and China remained the sole bastions of easy monetary policy. |
| Outlook | • | August is typically a month for holidays, as people make use of the last true summer weeks to prepare for autumn and winter. For markets, however, this year has seen a continuation of conflicting data points, jittery markets and uneasy central bank commentary. With reasons for optimism and pessimism alike, the course for equities in the remainder of 2022 is likely to be as non-linear as in the preceding months. |
| • | Inflation continues to surprise to the upside. What’s more, CPI prints of 9.4% in the UK, 9.1% in the US and 8.6% in the euro zone mask a rise in prices that is significantly higher in essential goods like energy, food and raw materials. Higher prices tend to reduce consumption, while eroding corporate profitability. Thus, as Europe prepares for a winter with a Nord Stream 1 pipeline that is, at best 20% operational, recession has become the base-case scenario for most investors. | |
| • | Indeed, the US has already reported its second back-to-back quarter of negative GDP growth (-0.9%). While Treasury Secretary Janet Yellen views this as insufficient in and of itself, both US and euro zone composite PMI data have fallen below 50, the level seen as indicating an expected contraction in activity. Outside the Energy sector, many corporate revenue and earnings expectations are being revised down consistently, if not abandoned altogether. | |
| • | Yet expectation of a recession is partly what has fuelled the recent surge in share prices. Even as central banks around the world scramble to hike rates fast enough, markets (as illustrated by the Fed Funds Futures) are taking the view that by March 2023, monetary policy will once again be on a downward trend. Asset prices ballooned in an era of easy money, and with many valuations considerably lower than they were eight months ago, some investors are already feeling bullish. | |
| • | Amid these conflicting expectations, our focus on fundamentals remains steadfast. Multiples across the portfolio have contracted, yet earnings expectations have proven largely resilient. Historically, our preference for quality stocks means that, even in the event of a full-blown recession, underlying earnings remain more robust than the broader market. Macroeconomic headwinds mean sentiment may continue to dictate share prices for the short-term. Yet, we continue to trust that our portfolio companies and the strength of their business models will drive performance in the long-run. | |
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August Issue 2022
Summary
At the start of August, weaker economic expectations had the effect of boosting global equity markets. Hopes that softer growth would spur a return to an accommodative monetary policy were enough to buoy growth stocks that had otherwise been leaden year-to-date.