Fed raises, stocks rally
SUMMARY OF MARKETS
July ended with a bang, with equities and bonds rallying nearly across the board. This brings us to the end of an eventful month, the best one so far in 2022. If you ask me to square the circle on how July was such a winner for traditional financial asset classes with all of the headwinds out there, I really couldn’t. Has that much really changed positively since June?
Inflation continues to rage in the US, UK and Eurozone
2Q22 GDP in the US was confirmed negative for second quarter running
Corporate earnings were mixed
The Fed, BoE and ECB are all tightening monetary policy aggressively
No significant change as far as Ukraine-Russia war (negative influence on energy and food prices)
Growth in China remains questionable due to periodic COVID shutdowns and potential issues in the property sector (supply-chain disruptions, growth of Chinese economy and domestic consumer demand all under pressure)
None of these ongoing issues seemed to matter much in July though as US equities recorded the biggest monthly gain since November 2020, reversing some of the sharp declines experienced in the first half of this difficult year. European and Japanese equities also recorded solid gains, with China and the emerging markets suffering from (amongst other things) the unusually strong US Dollar. US Treasuries also rallied in July as yields plummeted. This was the first month this year that the 20+ year UST bond index has been positive. Here’s a quick summary of the assets / indices I follow and their July return vs 1H2022 and YtD.
More detail is in the section of this update with the tables, which you can go to directly here.
Stocks and US Treasuries weren’t the only asset classes that improved as we start the second half of 2022. This is how July looked for some others:
Corporate credit stabilised early in the month and then improved (measured by spread migration), for both investment grade and high yield (USD- and EUR-denominated)
Bitcoin and brethren seem to have emerged from their most recent crypto winter (see E-MorningCoffee article here), with the benchmark cryptocurrency up 20.3% in July
Oil has moved into a lower trading range of $95-$100/bbl, down 7.1% in July
The U.S. Dollar reached a mid-month high although it has weakened slightly since then, still up 1.1% in July
Gold fell below $1,800/oz in early July and then below $1,700/oz at one point, until a rally during the last week of the month clawed back some of the monthly losses; gold was down 1.2% in July.
Why have markets performed so well in spite of the concerns I mentioned at the onset of the update? I attribute this to the following:
Economic data in July was largely as expected even though inflation continues at unsustainably high levels and global demand is slowing
Earnings expectations were beaten down so badly after 1Q22 earnings that companies just delivering “around consensus” was good enough, almost contributing to a relief rally
The warning signs of a recession – or at least a significant economic slowdown – in the US, UK and Eurozone are increasing, with the UST yield curve (2s-10s) inverting mid-month and yields across the board decreasing
Technical factors might have contributed too, as far as highly leveraged investors (i.e. margin players) being weeded out and short covering in July as investors could have been covering short positions as prices moved higher.
Don’t get me wrong – I loved July. Who wouldn’t that is long, especially after so many months of negative returns? However, I believe that July will prove to be an anomaly, and that these sorts of gains will not continue given the challenging backdrop and tricky road ahead.
The Fed and other central banks will continue to raise interest rates
Many companies will be unable to increase their revenues at the same pace as their cost bases (due to wage inflation), leading to margin erosion
The strong U.S. Dollar will continue to affect demand for dollar-based products / commodities and dollar-based economies
The price of oil remains highly elevated
I don’t think this means that equities are due a harsh move down, but I do think that we are near the top of a trading range with more downside from here than upside. If I was asked to clarify, I would say the S&P 500 will bounce around in a trading range of 3,700 to 4,100, unless there is something unexpected – positive or negative – on the horizon.
ECONOMIC AND GEOPOLITICAL NEWS THAT MATTERED THIS WEEK
There was a slew of economic news this week from the US and Europe, largely mixed but tilted towards a continued gradual slowing of the world’s largest economies. “Gradual” is good, with investors seeming to take it in stride as equities and bonds rallied in the US and Europe. Earnings played their roll, too. It was not that earnings were spectacular from the likes of the FAMAG companies and many others in the US and Europe, but rather that they were “close enough” after the shock of 1Q22 misses and beaten-down expectations. Indeed, it was the tech-heavy NASDAQ Stateside that led the stock rally in the US although – to be fair – the rally was fairly broad-based. Here is some of the news that mattered this past week.
Fed follows expected script
The Federal Reserve raised the Fed Funds rate 75bps as expected on Wednesday, the second large increase in the overnight bank rate in consecutive months. The FOMC statement is here, and the video of the press conference with Mr Powell following the rate decision is here. There were no real surprises as far as the Fed’s ongoing quest to bring inflation back to the 2% target rate, with the tools including further increases in the Federal Funds rate and an ongoing reduction in the Fed’s balance sheet (“quantitative tightening”). Mr Powell was not willing to guide on timing or magnitude of future rate increases, but pundits seem to be expecting 50bps at the next FOMC meeting September 20-21, at which the Fed will also provide updated economic projections. Somehow, investors interpreted Mr Powell’s comments at the press conference following the FOMC meeting as a potentially dovish tilt, but I didn’t see it this way at all.
Corporate earnings (especially FAMAG)
A slew of S&P 500 companies released earnings this past week, and you can find the update from Lipper Refinitiv here. Several European companies also released results for 1H22, with banks and energy companies being primarily in focus. Refinitiv also provides an update on aggregate STOXX 600 earnings, which you can find here. Most eyes this past week were on the FAMAG stocks, all of which released earnings. There was a fair amount of apprehension ahead of the earnings releases which I wrote about earlier this week in an article you can find here: “FAMAG earnings: investors on edge”. I have included one of the tables from this article below with actual revenues and EPS added on the right, along with the weekly performance of the stocks.
The earnings of the tech giants were mixed, with META being the only significant disappointment amongst the big five.
Global energy giants – including Shell, Total, ExxonMobil and Chevron – also served up record profits (BP reports this coming week). European bank results were largely mixed.
US slides into technical recession
The Bureau of Economic Analysis released 2Q2022 GDP for US, and GDP declined 0.9%, the second consecutive quarter of decline (here). 1Q22 GDP was also finalised (third reading), down 1.6% following strong 4Q21 growth. This two-consecutive quarter decline meets the technical definition of a recession but it’s impossible to reconcile this with such a tight US labour market (recall that unemployment in the US is 3.6%). The “recession or no recession” call will ultimately be made by the National Bureau of Economic Research. Personal consumption expenditures on goods fell during the quarter (-4.4%), whilst expenditures on services increased (+4.1%). The bizarre circumstances of declining (real) GDP and concurrently a tight labour market is a result of highly unconventional pandemic stimulus hand over fist. The economy might have slowed but it certainly doesn’t feel like a recession. US PCE and wages / employment
The most-watched indicator of US inflation by the Fed – personal consumption expenditures – was released on Friday by the Bureau of Economic Analysis (here). PCE increased 1.0% in July, with YoY PCE increasing 6.8%, the highest level in 40 years. Excluding food & energy, the July increase YoY was 4.8%. Perhaps most telling is that real PCE only increased 0.1% in July, illustrating how inflation is eating away at consumption expenditures.
Eurostat released flash CPI figures for July for the Eurozone (here), and the result was a further increase in inflation in the currency bloc to 8.9% in July (YoY), from 8.6% in June (YoY).
Below are some of the key data and dates on which to focus.
153 more S&P 500 companies report earnings this coming week (week of Aug 1st), include ATVI, PINS, L, ABNB, BP, CAT, MTCH, PYPL, SBUX, CVS, MET, CLX, BABA, DASH, LLY, IRM, K and SQ
Bank of England Monetary Policy Statement on Thurs (Aug 4th), consensus is an increase in the Bank Borrowing Rate by 25bps (to 1.50%), although Reuters reported that some economists believe that a larger 50bos increase might be possible
Economic data to include
Eurozone: unemployment on Monday and retail sales on Wednesday
US: manufacturing, services data for July throughout week
Corporate bonds (credit)
Safe haven and other assets