A sharp turnaround from mid-month as the Fed strikes a less hawkish tone
Global equity markets rallied sharply in July, led by the US where stocks gained 9%. Other major markets recorded gains of 4-5%, while bond markets also rose across the board, led by the inflation-linked sector. The month began on a negative note as US inflation data revealed a further 9.1% surge in the CPI for June, the biggest annual jump since 1981. However, equities staged a sharp turnaround from mid-month following the Fed's less hawkish statement and better-than-expected earnings from leading mega cap technology stocks.
The Fed raises by 0.75% but signals caution ahead
The 9.1% surge in CPI for June fuelled concern that the Fed would be forced to raise rates more than expected to stamp out inflation, causing a recession in 2023 in the process. The Fed subsequently raised rates by 0.75% for the second month running, but this time the accompanying statement was more dovish. Fed Chair Powell described it as an "unusually large" increase, saying that "as the stance of monetary policy tightens further, it will become appropriate to slow the pace of increases". He refuted the idea that a recession was imminent, citing strength in the labour market with unemployment still at a very low 3.6%.
Powell also admitted that the need to curb inflation might ultimately lead to a recession, stating that "the path to a soft landing has narrowed" but that failing to restore price stability would be a "bigger mistake". Bond markets rallied as yields dropped back from recent highs on hopes that the headline rate of inflation may be peaking. The ISM manufacturing survey showed an unexpectedly sharp fall in prices paid as supply chain pressures eased and commodity prices closed below recent highs.
Technology giants deliver reassurance on growth
Equities staged a sharp turnaround from mid-month, helped by better-than-expected earnings from leading mega cap technology stocks. Alphabet, Microsoft and Texas Instruments posted double-digit revenue growth and expressed optimism about current trading, soothing fears that a strong dollar and weakening economy would hurt growth. On an intra-day basis, the technology sector surged 20% and the overall US market recovered 13% from its low.
Multiple challenges for the UK as the ECB ends negative rates
The UK economy continued to face multiple challenges. The surge in living costs was squeezing consumers at a time when credit costs were also rising, while labour unrest and a political vacuum created further uncertainty. GDP grew by 0.5% in May, following a decline of 0.2% in April, while headline inflation had yet to peak. Sterling remained close to lows against the dollar, reflecting concern over the potential for a lengthy period of stagflation. The market was trading at a discount, reflecting these concerns.
The ECB raised rates for the first time in more than a decade, by 0.5% to zero, marking the end of negative rates. It also announced a new policy to prevent spreads between bond yields of individual countries widening and deal with the risk of Eurozone fragmentation. The transmission protection instrument (TPI) was immediately dubbed "To Protect Italy" and underwhelmed investors with its lack of detail. The situation was not helped by political turmoil in Italy: the resignation of Prime Minister Mario Draghi following a confidence vote left an autumn election on the cards.
A note from the desk
I am pleased to share our monthly update on market events. The overview seeks to summarise market movements together with our views and the rationale for the positioning of investments going forward. As always, should any aspect of this commentary prompt a question, we would welcome the conversation.
Martyn Charlwood · Managing Director
One of the most unique periods in financial markets
2022 remains one of the most unique periods in financial markets. The combination of higher inflation and aggressive monetary tightening has created an environment where there are few safe havens. Bonds have fallen in tandem with equities as investors have had to deal with the unusual combination of rising rates and falling growth simultaneously. However, extended periods of stocks and bonds falling together are rare.
Markets rallied on hopes that inflation has been defeated and the Fed will start cutting rates in early 2023. The debate was now firmly on the likely extent of a growth slowdown and whether it would result in a soft landing or recession. Recent data pointed to a slowdown but was not yet weak enough to signal a recession. The earnings season so far painted a similar picture.
The bad news was that the Fed was unlikely to relent anytime soon. While inflation would cool, it was not expected to fall to target levels in the foreseeable future. Bond markets were anticipating a peak in interest rates of 3.5% by early 2023, but there were downside risks to this forecast should inflation prove more embedded in the global economy. A key factor would be the future direction of energy prices.
Extended periods of stocks and bonds falling together are rare, and seldom last long.
Overall, there were reasons for optimism, but we remained cautious. A relief rally was overdue, as sentiment had fallen to levels not seen since the peak of the Covid crisis. A sustainable recovery may require more concrete evidence that inflation is on a downward path. The debate on the likely extent of any growth slowdown continued, and while recent data did not yet signal recession, the risk of one in 2023 could not be dismissed, particularly if energy prices remained elevated through the winter months.
Trading activity has been higher than usual as we have taken advantage of the increase in market volatility. We are inclined to raise cash on any further strength in anticipation of a better buying opportunity for equities later this year.
New positions added on weakness
Two new positions were added last month following market weakness. However, following the subsequent sharp rally, we are inclined to raise cash on any further strength in anticipation of a better buying opportunity for equities later this year.
Gold for diversification and protection
A new position has been added in the iShares Physical Gold ETC. The gold price has fallen back to test its long-term uptrend line following a strong move up earlier this year, providing an attractive entry point. It should provide valuable diversification given the risk of stagflation and ongoing geopolitical tensions.
Cautiously optimistic, prepared to act
Overall there are reasons for optimism, but we remain cautious for now. A sustainable recovery may require more concrete evidence that inflation is on a downward path, and we stand ready to deploy cash when the opportunity arises.
Important information
This article is a marketing communication intended for general information only. It does not constitute personal advice, a recommendation, or an offer to buy or sell any investment. If you are unsure whether an investment is suitable for your circumstances, please seek personal advice.
Past performance is not a guide to future performance. The value of investments and any income from them can fall as well as rise. Capital values are at risk and not guaranteed. Forecasts and views expressed in this commentary represent our assessment at the time of writing and are subject to change.
To discuss how this commentary applies to your own portfolio, we would welcome a conversation.
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