Investors and analysts were left grappling with unexpected inflation figures and rate hikes in July, creating a dramatic narrative reminiscent of the contrasting characters of Barbie and Oppenheimer. During the month, there was a marked reduction in the UK inflation rate, while the European Central Bank raised rates. The US economy showed resilience, but there is now speculation about the end of the Fed’s aggressive hiking cycle. China's manufacturing sector continues to face challenges. The global bond market struggled, while commodities and gold saw gains.
There was a surprising downturn in the rate of inflation in June, falling to 7.9% from 8.7% in May, as wage growth equalled a record high.(1) This fall has meant that rate rises of any notable magnitude are now considered to be less likely and also potentially signals that the peak in rate hikes may not be far off. Additionally, unexpected jumps in mortgage approvals in June further added to the mixed economic signals.
The European Central Bank (ECB) raised rates by 25 basis points to a 23-year high of 4.25%, signalling the commitment of the bank to tame inflation.(2) However, President Christine Lagarde's comments about a potential pause in September caused the euro to tumble. Inflation slipped to 5.3% and GDP exceeded market expectations.(3) While the Eurozone's monetary policy trajectory remains uncertain these data points suggest there are some positive signs of resilience in the economy.
The US economy continued to demonstrate resilience in the second quarter, with GDP growing at a rate of 2.4% keeping the recession-mongers at bay. This surpassed economists' consensus estimate of 1.8% and has led to increased optimism among investors.(4) The market is now speculating again that the aggressive US rate hiking cycle may be coming to an end. In July, the Federal Reserve raised interest rates by 25 basis points, bringing the target range to 5.25% - 5.50%, the highest level in over 22 years.(5) Despite rates climbing higher, the Dow Jones Industrial Average experienced its longest winning streak since 1987 in July. This was driven by expectations of falling inflation in line with the Fed's target rate, indicating that interest rate hikes may have reached their peak.
In July, the Bank of Japan (BOJ) made a decision to adjust its long-standing yield control policy. This decision came shortly after the Federal Reserve chose not to make any commitments regarding future interest rates, and the European Central Bank hinted at potential pauses. The BOJ's guidance remained the same, allowing the 10-year yield to fluctuate around the 0% target by 0.5%. However, the BOJ clarified that these figures would now be seen as ‘references’ rather than strict limits.
China's manufacturing sector contracted for the third consecutive month as it continues to face challenges, but the situation is improving compared to previous months. The slower pace of contraction suggests that the government's efforts to stimulate the economy are having some effect. However, a sell-off in Chinese banks followed Goldman Sachs' downgrading of some major Chinese banking lenders to a ‘Sell’ as worries over the sector deepen as the economy slows. Additionally, China's inflation data for June surprised on the downside, with consumer prices slipping 0.2% on the month, leaving annual CPI flat.(6) Producer prices also fell -5.4% on the year, the sharpest decline since late 2015.(7) Furthermore, China's GDP growth for the second quarter was 6.3%, marking a slower pace of growth compared to the first quarter.(8) On the other hand, Latin American markets continued to benefit from the deteriorating relationship between the US and China, with countries like Mexico being big beneficiaries, aided by a weaker dollar.
The IMF revised its growth forecasts for the global economy, indicating a more positive outlook. However, concerns over tighter credit conditions, depleted household savings in the US, and a slower-than-expected recovery in China raise cautionary flags. While the IMF raised its growth prediction for 2023, it underscored the need for vigilance in navigating potential headwinds.
Emerging markets, especially China and Latin America, stole the limelight from developed markets in July. MSCI China H-Share index experienced a late rally as markets anticipated fresh economic stimulus measures and a focus on boosting domestic demand, ending the month 3.54% higher. This optimism propelled emerging market equities, with the MSCI Emerging Market Latin America index witnessing significant gains too, rising 3.90%. The broader MSCI Emerging Market index closed the month higher, buoyed by China's late surge, closing the month up 4.96%.
July proved to be a challenging month for the global bond market; it was the only asset class to end underwater. Initially, yields in developed markets soared to decade highs, causing distress among bond investors. The trigger for this surge was not immediately clear, but the release of strong US non-farm payroll data played a significant role. Bond markets grappled with the dilemma of whether a strong figure is good for risk, indicating recession avoidance, or bad news, implying higher interest rates. However, a rally towards the end of the month, driven by softer inflation data, provided some relief. The Bloomberg Global Aggregate index returned -0.40%.
Value emerged as the preferred investment style in July. The best-performing asset class, commodities, saw a surge in prices, driving the Bloomberg Commodity GTR index to post significant gains, rising 4.88% by the end of the period. Some weakness in the dollar and expectations of interest rates reaching a peak in the cycle supported prices in the asset class.
The US Dow Jones Industrial Average index was also a hotspot towards month end as it experienced its longest winning streak in decades. Elsewhere, The Cboe UK All Companies index returned 2.57% and was the best-performing developed economy stock market of those measured. The S&P 500 returned 1.96% and the TOPIX returned 1.9%, MSCI Europe ex UK returned 1.73%. The NASDAQ 100, which is more technology-focused, rose 2.60%.
Gold experienced a boost in mid-July, hovering near one-month highs. The precious metal benefited from a weakening US dollar, which fell to its lowest level in over a year, and falling US Treasury yields. These factors reduced the opportunity cost of holding non-yielding bullion, making gold an attractive investment option. LBMA Gold Bullion saw prices rise 0.91% by month end.
MSCI ACWI REITS index also benefited from falling bond yields and interest rate expectations, ending the month 0.91% higher.
Considerations for long-term investors
The equity market in 2023 has become increasingly narrow, with a few mega stocks driving the majority of returns in the S&P 500. The dominance of AI-related stocks has further exacerbated this trend, with the NYSE FANG+TM index that includes; Facebook, Apple, Amazon, Netflix and Alphabet's Google—plus another five actively traded technology growth stocks—Alibaba, Baidu, NVIDIA, Tesla and Twitter (recently rebranded as X) of mega tech stocks significantly outperforming the broader index. The market's vulnerability is highlighted by the shrinking number of S&P 500 stocks outperforming the index. The market's future trajectory may depend on whether there is a substantial correction or a broadening out of market performance.
In such market conditions, it can be very tempting to chase returns from a small minority of stocks that are dominating the headlines due to ‘outperformance’. However, it is very rare for markets to maintain a narrow focus for long. Long-term investors should consider diversifying their portfolios beyond the mega tech stocks that are currently driving the market. While these stocks may be performing well now, relying too heavily on a few stocks can increase the risk of your portfolio.
Investors should look for opportunities in other sectors and industries that have the potential for growth. This could include sectors such as healthcare, renewable energy, or consumer staples. By diversifying across different sectors, and through the use of funds, investors can reduce their exposure to any one particular stock or industry. And not just sectors but across asset classes too, such as bonds, alternatives and property.
Lastly, investors should be prepared for potential market corrections. The current market dynamics may not be sustainable in the long run, and a correction could lead to a decline in the performance of the mega tech stocks as well as the wider market. Having a well-diversified portfolio and a long-term investment strategy can help mitigate the impact of short-term market volatility.
Sources: FE Analytics (monthly performance figures for funds and market 30/06/2023 to 31/07/2023). Qualitative commentary from TILLIT meetings with fund managers. Index returns are expressed in sterling terms unless otherwise stated.
(1) Source: UK Inflation
(2) Source: European Central Bank base rate
(3) Source: Eurozone CPI
(4) Source: US GDP
(5) Source: Federal Reserve base rate
(6) Source: China Consumer Price Index
(7) Source: China Producer Prices
(8) Source: China GDP
Date of publication: 4th August 2023
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