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.
Equity Snapshot
| United States | • | US equities initially rallied as a slight easing in the annual rate of US inflation boosted speculation that the Federal Reserve (Fed) may be less aggressive in raising rates. By mid-August, the S&P 500 Index had rallied around 15% from its lowest point in mid-June while the Nasdaq Index had rebounded more than 20%. US shares later reversed direction when Fed officials issued a series of hawkish statements, with both the S&P 500 and the Nasdaq closing the month lower. |
| • | Hopes that the Fed may relax its aggressive tightening stance were dashed after Fed Chair Jay Powell stressed that the US central bank “must keep at it until the job is done” by raising rates to smother inflation. Following this statement, the futures market moved to price-in a federal funds rate of 3.8% by February 2023, compared to the current range of 2.25-2.5%. | |
| Europe | • | European equities retreated (in EUR terms) over August amid growing recessionary fears along with concerns that sharp hikes in interest rates will be needed to combat inflation. Gas prices soared once again, and several European nations introduced measures to help households hit by a cost-of-living crisis: Germany pledged EUR 10 billion in tax relief, while France agreed to a EUR 44 billion support package that includes the nationalisation of energy supplier, EDF. As the heatwave continued, Europe faced the worst drought in 500 years with low water levels threatening to disrupt key transportation routes, such as Germany’s Rhine River. |
| • | The flash estimate of S&P Global’s eurozone composite purchasing managers’ index (PMI) for August fell to an 18-month low of 49.2. This marked the second consecutive month that the index has been in contraction territory, with higher inflation sapping demand in the services sector. Headline inflation continued to accelerate, rising to a fresh record high of 9.1% in August. European Central Bank officials indicated that another large hike in eurozone interest rates was likely in early-September: while a 50-basis-point hike is the most likely outcome, there is growing speculation that the increase may be even larger. | |
| Asia | • |
Equity markets in Asia delivered flat returns over August as investors digested corporate earnings and hawkish statements from the US Federal Reserve. While China eased its monetary policy, other central banks in the region raised rates to combat rising inflation. Chinese and Hong Kong equities declined as elevated COVID-19 cases, power cuts due to a severe drought, and a continued housing market slowdown in China weighed on investor sentiment. Taiwanese and Korean equities were broadly flat, with leading chipmakers warning of softening demand from weaker consumer spending. Elsewhere, the Reserve Bank of Australia raised rates to the highest level since 2016. Indian equities rallied, as inflationary pressure eased to a five-month low in July. ASEAN markets were the top performers with Indonesia, Thailand, and Philippines posting solid gains. |
| Bond | • | Signs that inflationary pressures may be starting to moderate in the US initially boosted speculation that the Fed might start to scale back the size of future rate rises. Fed policymakers acted swiftly to dampen such speculation and the message was reinforced by Fed chair Jay Powell’s speech at the annual Jackson Hole gathering of central bankers. In Europe, inflationary pressures continued to accelerate, and ECB officials indicated that another sizeable increase in rates was likely in early-September. In the US, the 10-year Treasury yield climbed back above 3.0%, while the 10-year German Bund yield traded above 1.5% for the first time since late-June. |
| Outlook | • | 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. As autumn begins however, bad news really is proving to be bad news. |
| • | In the US, the S&P Global composite purchasing managers’ index (PMI) in August tumbled to 45.0, its lowest reading since May 2020, at the height of the pandemic. Data in Europe and China are turning similarly negative. What has changed however, is the market’s perception of how willing central banks are to keep raising interest rates in the face of such negativity. | |
| • | Such doggedness from central banks reflects the persistent nature of inflation. In the UK, for example, a combination of supranormal energy prices and rising labour costs has pushed inflation to a 40-year high of 10.1%, with the expectation that it will top out at 13% later this year. Combined with weaker growth, the resulting stagflationary environment will have the likely effect of reducing consumer spending power and eroding corporate margins. | |
| • | Nonetheless, there are glimmers of hope. M2 money supply began reducing in February 2021, which is often a leading indicator for deflation. Similarly, as post-Covid supply chains begin to normalise, so too have prices for commodities like lumber, copper and steel. The latter may also reflect the impact of high prices, which in themselves are a cure for high prices. Signs of companies reducing inventories, many of which were built during periods of elevated costs, also bode well in this respect. | |
| • | Amid these conflicting expectations, our focus on fundamentals remains steadfast. Historically, our preference for quality stocks means that, even in the event of a full-blown recession, underlying earnings remain robust. Companies with high value-add products, pricing power and strong management teams tend to out-earn the broader market in these conditions. At the same time, in a world in which global growth is slowing, companies that can expand earnings independently of the broader cycle will become more valuable. With valuations having become progressively more attractive, we remain confident that these characteristics will come to be appreciated by the market in the long-term. | |
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September Issue 2022
Summary
The inflation narrative continues to wrongfoot global equity markets. The first full week of October saw softer than expected US manufacturing data swiftly followed by a stronger than expected jobs report. Stocks whipsawed as a result, surging with hopes of a Fed pivot and falling as these were soon dashed.