Equity markets continued their rebound last week. In local currency terms, global equities gained 3.0% and are now up 9% from their low. They have now recovered just over one third of their losses since early January. In sterling terms, markets rose 2.1% last week and have now regained a little over half of their losses.
The gain in equities was accompanied by a continuation of the rally in bonds. 10-year US Treasury yields dropped a further 0.14% to 2.64%, down from a mid-June high of 3.5%. 10-year UK gilt yields have also dropped back 0.8% from their high to 1.85%, leading to gilts regaining a quarter of their 20% loss since early January.
There was a lot of news out last week but in truth none of it obviously warranted the market moves. Most important, the US Fed as expected raised rates by 0.75% to 2.25-2.5%. Markets took comfort from the Fed saying that the size of further tightening moves would depend on incoming data and that as policy tightens further, it should become appropriate to slow the pace of increases.
All the same, this still leaves another 0.5% hike firmly on the cards for September with further increases likely to take rates up to 3-3.5% by early next year. There is little obvious to justify the market’s increasing confidence that rates will peak no higher than this and will be falling again by next spring.
That said, the second quarter US GDP data did at first glance seem to do exactly that. GDP was weaker than expected, falling at a 0.9% annualised pace. This was the second consecutive decline, meeting the headline definition of a recession. However, a smaller build-up in inventories was largely to blame. While growth has definitely weakened significantly, the slowdown looks unlikely to meet the official definition of recession which takes into account a wider range of variables than just GDP.
Inflation also for the moment remains the Fed’s No. 1 focus and is still far from under control. The headline rate should fall back somewhat over coming months on the back of the recent decline in commodity prices. But there is precious little sign of core inflation moderating – the Fed’s favourite measure edged up unexpectedly last month to 4.8%.
The second quarter earnings season is in full swing and has been a major market focus. The US tech giants reported last week and by and large, their results beat expectations, easing worries that the downturn in growth would have taken its toll. This, along with the fall in bond yields, has been behind the recent rebound of the sector.
Still, the market does appear to be looking only on the bright side. The consumer staples giant Walmart cut its profit targets again, hit by the surge in inflation. At the overall market level, earnings should post a gain of around 7% on a year earlier. But exclude the energy sector, where profits have soared, and earnings should see a small decline.
Moving onto the Eurozone, second quarter growth was considerably higher than expected. GDP grew at an annualised 2.8% rate, on the back of strong performances from France, Italy and Spain as their economies rebounded from covid.
However, the good news stopped there. Eurozone inflation yet again exceeded expectations in July, hitting a new high of 8.9%. Moreover, recent relief that Russia had restarted gas supplies through the Nord Stream 1 pipeline proved short-lived as it announced it would cut flows from 40% of capacity to 20%. Rationing of gas supplies in Germany is very possible this winter and a recession in the Eurozone is looking very likely.
Here in the UK, on the economic front at least, there was no important news other than Sunak jumping belatedly on the Truss tax-cutting bandwagon. This coming week, the Bank of England meeting on Thursday will be the centre of attention. Most likely, it will follow the lead of the Fed and ECB and speed up the pace of tightening, raising rates by 0.5% to 1.75%, a step up from the 0.25% moves seen so far.
All said and done, the current rally in equities looks more likely than not to go the way of the 5-10% bounces already seen in February, March and May, all of which proved to be of the dead-cat variety. While we do believe equities will see a sustained recovery down the road, it looks very premature to believe that this is it. Further significant policy tightening still lies ahead of us, as indeed probably does a recession in the US, UK and Europe – albeit a relatively mild one.
Then again, predictions a few weeks ago that the lionesses would win the Euro 2022 cup also looked decidedly premature.
Rupert Thompson – Investment Strategist