My view on what's going on in the financial markets and the global economy, and a few other things that might interest me from time to time.

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  • tim@emorningcoffee.com

Week ended July 1, 2022

Same ol same ol


[SKIP THE COMMENTARY AND GO STRAIGHT TO THE TABLES]


SUMMARY OF MARKETS


The recovery in global equities the week before provided investors with only a temporary hiatus from pain as the slow drift downwards in global equity markets resumed this week. At least we ended on a constructive tone though as US stocks bounced off of session lows early Friday morning to stage a solid recovery. The S&P 500 was up around 1% on Friday, little solace to investors that experienced another down week (3.2%) and an overall dismal month (down 8.4% for June). Thursday marked the end of a horrific first half of the year for investors in US stocks, with the S&P 500 down a whopping 20.6%, the index’s worst first half performance since 1970. The FTSE 100, the STOXX 600 and the Nikkei 225 were also down on the week, and all ended the first half of the year in negative territory too (see tables). About the only glimmer of hope recently has been in Chinese equities, which remain considerably cheaper than developed market equities. The Shanghai Composite delivered a solid 6.7% (positive) return in June, far outperforming the US, European and Japanese equity markets. COVID-related shutdowns in China seem to have eased, and Chinese services and construction PMI data showed improvement in May for the first month since February.


Fortunately, bonds have bucked the losing trend the last couple of weeks as prices of US Treasuries have come off of the lows reached in mid-June. The yield on the 10y UST fell back below 3% on Thursday (Friday close 2.88%), its lowest level since early June. The strong performance of Treasuries in the second half of June was not enough to erase losses during the first half of the month, as the total return on both 7y and 20y+ USTs was negative for June albeit modestly. Similar to US equities though, the total returns in the UST market for the first half of 2022 were sharply negative, with the 7-year and 20+ year UST total return indices down 10.6% and 21.2%, respectively. Perhaps the rally in bonds will prove to be temporary, although I am fairly convinced that yields will stay largely in or around these levels. The measure of inflation on which the Fed most focuses – real PCE – declined 0.4% in May (vis-à-vis April), suggesting that inflation in the US has perhaps peaked. According to an updated analysis released by the Federal Reserve Bank of Atlanta (see “Atlanta Fed GDPNow Estimate for 2022: 2Q”), the forecast for 2Q22 GDP is now for a decline of 1.0% for the quarter, whereas on April 29th the forecast for 2Q22 GDP was for growth of 1.9%. Since GDP for 1Q22 for the US was negative 1.6% (see BEA release here), if real GDP growth were to be negative in the second quarter, it would mean the US is already in a technical recession. Pundits and investors are increasingly flocking to this camp, as bonds signal that the US has passed peak inflation and economic growth is expected to slow further. Things are very different in Europe though, as inflation continues to increase in the UK and the Eurozone. Eurozone flash CPI in June was 8.6%/annum, a sharp increase over May (8.1%) (see Eurostat data here). At the ECB’s annual forum in Portugal on Wednesday, Messrs Powell and Bailey, along with Ms Lagarde, put on their “game-fighting inflation faces”, largely agreeing that after many years of low global inflation, the focus in developed market economies has now shifted to bringing down raging inflation. I have little doubt that inflation will be brought down, but the question remains “at what cost”?


In other markets, the US corporate bond market is continuing to experience a (relative) flight-to-quality as credit spreads widen across the credit curve, most pronounced as rating buckets get lower. High yield bonds are correlated with equities, so the weakness in high yield bonds is not surprising given what is occurring in the US stock market. High yield spreads are the widest they have been since the summer of 2020 (early post-pandemic period). Higher yields and choppy market conditions are causing primary volumes to plummet, as many companies also are faced with a less urgent need to raise debt in the bond market (because so much refinancing was done in the last 24 months when yields were at or near record lows).


Cryptocurrencies remain under severe pressure and the collateral damage into crypto-hedge funds and brokers continues. Hedge fund crypto specialist Three Arrows Capital filed for bankruptcy on Friday following much speculation in the market, even as the strongest crypto advocates like Michael Saylor of MicroStrategy (MSTR) continue to load up on beleaguered Bitcoin (see here). Cryptos are an alternative “off-the-run” asset category, but the deflating of this market is reverberating throughout risk markets. Oil and gold were also weaker on the week, whilst the US Dollar continues to defy gravity as it strengthens, with the casualties being the Euro and Pound (amongst others). The S&P/Case-Schiller US National House Price index was released this week for April, with US residential real estate prices up 2.1% in April (vs March), as home prices continued their rapid increase. Since the beginning of 2020 (per-pandemic), US residential real estate prices are up an amazing 41.6%. However, I would caution that the Case-Schiller data is through April only, and more recent residential real estate price indicators are showing slowing prices, which is inevitable given that the average 30-year US mortgage rate – which was 3.11% at the beginning of this year – has now nearly doubled to 5.70%.


Any way you slice it, the week, month and YtD has been poor for most financial assets as the narrative around a pending recession in the US and Europe gains traction and looks increasingly inevitable.


WHAT’S NEXT?


This coming week is holiday shortened in the States, with the US stock and bond markets closed on Monday for the July 4th holiday. As we saw two weeks ago, maybe the long weekend will give investors in US stocks and bonds a chance to catch their breath and start the second half of the year on a more positive tone. Still, all sorts of risks remain on the horizon. June data will begin being released this coming week which will provide an idea of the direction of the global economy. Some of the key upcoming markers in July include:

  • June US CPI to be released July 13th;

  • S&P 500 2Q earnings releases start the week of July 12th, with the banks as is customary being the initial focus (JPM and MS release earnings June 14th);

  • FOMC minutes from the June 14th-15th meeting to be released on or around July 6th; the next FOMC meeting is July 26th-27th; and

  • The Governing Council of the ECB will meet on July 21st.

THE TABLES


Global equities


US equities


US Treasuries


Corporate bonds (credit)



Safe haven and other assets


_________________


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