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Global equities (+7.1%) rebounded during the month, ending July with an 11.7% loss year to date. Despite ongoing fears about persistently high inflation and rising interest rates, investors were encouraged by mostly resilient corporate earnings and moderating inflation expectations amid a sharp decline in commodity prices and slowing economic growth. The US Federal Reserve (Fed) hiked its target interest rate by 75 basis points (bps) for the second straight meeting in an effort to rein in decades-high inflation. Fed Chair Jerome Powell stated that he does not believe the US economy is in recession despite two consecutive quarterly GDP declines, pointing to positively performing areas of the economy. Investors have been concerned that rising rates would tip the US economy into recession, but so far, the economy has performed better than most expected. The European Central Bank (ECB) ended its negative interest-rate policy with a larger-than-expected 50 bps hike to combat inflation, even as ECB President Christine Lagarde warned of a darkening economic outlook. UK Prime Minister Boris Johnson and Italian Prime Minister Mario Draghi resigned from office, increasing political uncertainty in Europe during a pivotal time. In sharp contrast to the restrictive monetary policy of most global central banks, Japan maintained ultralow interest rates to support economic growth. China’s fragile economic recovery was strained by troubles in the housing market and supply-chain disruptions from the country’s zero-COVID policy and persistent virus outbreaks. The price of crude oil and gasoline fell during the month, providing some relief to consumers struggling with soaring energy prices, although natural gas costs surged.
US equities (+9.2%) registered their largest monthly gain since November 2020. Despite fears about aggressive monetary policy tightening, slowing economic growth, and recession, stocks advanced amid mostly better-than-expected corporate earnings and a decline in medium- and longer-term inflation expectations. Growth stocks significantly outperformed their value counterparts, fueled by a rally in technology stocks. Headline inflation accelerated 9.1% annually in June (5.9% at the core level) — the highest level in four decades — driven by higher gasoline, shelter, and food prices. This surprisingly large increase showed broadening inflation pressures in the economy, prompting the Fed to raise interest rates by 75 bps. The Fed’s policy statement acknowledged that spending and production have softened but emphasized that the strong labor market provides more scope for the economy to withstand the rapid tightening of rates. US GDP contracted 0.9% annually in the second quarter as high inflation, rising borrowing costs, and tighter financial conditions weighed on the economy. Data from FactSet indicated that 56% of companies in the S&P 500 Index had reported second-quarter earnings results by the end of July, with 73% of those companies reporting earnings that exceeded consensus forecasts. The blended year-over-year earnings growth rate for the index was 6.0%, better than estimates of 4.0% at the end of June. The forward 12-month price-to-earnings ratio stood at 17.1.
Economic data released in July signaled that the US economy continued to slow. However, broad-based strength in the labor market empowered the Fed to maintain its aggressive pace of monetary policy tightening to tame decades-high inflation. Nonfarm payrolls increased by 372,000, well above consensus forecasts of 265,000, and the unemployment rate held at an extremely low level of 3.6%. Initial jobless claims trended modestly higher, coinciding with hiring freezes and layoffs at some high-profile companies. Average hourly earnings grew 5.1% annually in June, down from 5.3% in May, potentially signaling that growth in labor costs has peaked. US retail sales increased by 1% in June, while consumer spending rose at a surprisingly strong 1.1% pace, a significant uptick from an increase of 0.3% in May. Adjusted for inflation, spending rose only 0.1% in June and personal incomes fell 0.3%, underscoring how high inflation has eroded purchasing power and tempered demand. The savings rate slipped to 5.1% — the lowest since 2009. Weaker perceptions about current economic conditions, the job market, and incomes drove a bigger-than-anticipated decline in consumer sentiment in July; the Conference Board’s Consumer Confidence Index declined 2.7 points, to 95.7, with purchase plans for large-ticket items receding. The housing market suffered from a mix of high prices and rising mortgage rates, which hovered near their highest levels since 2008. In June, new-home construction and existing- and new-home sales continued to decline.
Manufacturers remained optimistic despite concerns about the softening economy and signs of lower demand. The Institute of Supply Management (ISM) Manufacturing Index eased slightly to 52.8 in July, from 53.0, as new orders contracted for the second straight month, backlogs eased, and input prices increased at a much slower rate. The ISM Services Index cooled slightly to 55.3 in June, above consensus forecasts of 54.0 and still firmly in expansionary territory. Business activity strengthened, signaling that consumers continued to shift their demand preference from goods to services. Preliminary data for July indicated a more pronounced slowdown in services sector business activity as weaker demand and inflation weighed on sales and exports. Input prices rose markedly but at the softest pace since January, and companies were less optimistic about their outlooks. Small-business sentiment slumped to its lowest level since 2013 against a backdrop of rising inflation and labor supply constraints.
All 11 sectors in the S&P 500 Index (+9.2%) posted positive results. Consumer discretionary (+18.9%) was the top-performing sector, with automobiles (+31.1%) and internet & direct marketing retail (+26.9%) driving positive returns. Information technology (+13.5%) also outperformed, led by technology hardware, storage & peripherals (+18.3%), semiconductors & semiconductor equipment (+16.1%), and software (+10.3%). Despite the decline in crude oil and gasoline prices, energy (+9.7%) generated strong results, driven by better-than-expected earnings results from large index constituents. Health care (+3.3%) lagged, weighed down by losses in the pharmaceuticals (-1.2%) and biotechnology (-1.0%) industries.
European equities (+6.1%) generated robust gains despite elevated fears about recession, scarce natural gas supplies, persistently high inflation, and political turmoil in the UK and Italy. Investors reacted favorably to the ECB’s decision to raise interest rates by 50 bps, with eurozone inflation rising to a record high of 8.9% in July. The ECB also pledged to prevent escalating borrowing costs from precipitating a debt crisis in Europe, introducing a new bond-buying program, dubbed the Transmission Protection Instrument (TPI), to suppress “unwarranted” distortions in European government bond spreads that could obstruct the ECB’s ability to direct the eurozone economy. Bolstered by a surge in tourism, eurozone GDP grew 0.7% in the second quarter, well above forecasts of 0.1%. However, a growing number of economists forecast recession amid weakening demand and strains from inflation, supply disruptions, and natural gas shortages. Russia further cut gas flows through the Nord Stream 1 pipeline to 20% of total capacity. European Union (EU) leaders intensified planning for a scenario where Russian gas supplies would be completely cut off, with energy ministers approving a proposal for all EU countries to voluntarily cut gas consumption by 15% over the next eight months.
Recession fears were exacerbated by a worsening downturn in Europe’s manufacturing and services sectors. The eurozone manufacturing Purchasing Managers’ Index (PMI) contracted to 49.8 in July, from 52.1 in June, amid the steepest decline in production and new orders since the onset of the pandemic. Weaker demand pushed business expectations lower and led companies to scale back production and hiring, helping to ease supply constraints and driving input and output price inflation down by the most in 17 and 15 months, respectively. Preliminary data for July indicated that the services sector grew modestly, although the rate of expansion slowed considerably as new orders for goods and services continued to wane. European industry confidence markedly declined amid falling production expectations and weakening sales, while consumer confidence dropped, with households’ financial situations outlook hitting an all-time low.
In the UK (+3.5%), Boris Johnson announced that he would step down as prime minister after a deluge of government ministers and officials resigned. Conservative Party lawmakers will now vote to elect either former Finance Minister Rishi Sunak or Foreign Secretary Liz Truss to become the UK’s next prime minister on September 5. Soaring food and energy prices drove inflation to a 40-year high of 9.4% in July, prompting the Bank of England (BOE) to consider a 50 bps rate hike in August. Italy (+5.2%) was engulfed in political crisis after the collapse of the country’s coalition government forced the resignation of Prime Minister Mario Draghi, triggering new government elections on September 25. The ensuing political risk led to tighter financial conditions and raised doubt about the government’s ability to implement the reforms needed to access more than €200 billion of the EU’s post-pandemic recovery fund. Germany’s (+4.9%) economic growth stagnated in the second quarter, as the higher cost of oil and gas imports caused a large deterioration in the country’s trade balance.
Pacific Basin equities (+3.6%) rebounded in July, reversing the previous month’s decline. Australia (+5.0%) generated strong returns. Its central bank tightened monetary policy at the fastest pace on record by raising interest rates by 50 bps, bringing the cash rate to 1.35%. The bank has lifted rates by 125 bps since May amid widespread criticism over its decision to delay rate hikes even as inflation rose at a rapid clip. Inflation reached the highest level in 21 years, rising 6.1% annually in the second quarter. The reading was slightly below forecasts but was twice the pace of wage growth, pointing to an additional 50 bps rate hike in August. Job growth in June swelled by 88,400, pushing the unemployment rate down to a 50-year low of 3.5% and prompting economists to forecast more aggressive policy tightening. Retail sales rose 0.2% in June, the slowest rate this year and below projections. The skyrocketing prices of energy and food, as well as rising borrowing costs, began to weigh on consumer spending.
Japan (+4.0%) advanced. Despite a record surge in the number of COVID cases, the government refrained from reinstating restrictive measures. Rising inflation dampened consumer spending, with retail sales falling 1.4% in June after three consecutive months of growth. Core inflation grew 2.2% following a 2.1% rise in May, remaining slightly above the Bank of Japan’s (BOJ’s) 2% target for the third straight month. Citing the potential impact of lingering supply constraints, rising commodity prices, and the pandemic, the BOJ cut its economic growth forecast for this fiscal year from 2.9% to 2.4%. It also raised its core inflation forecast to 2.3%; however, it held interest rates at an ultralow level, warning of economic uncertainty and risks to the country’s fragile economic recovery. The unemployment rate held steady at 2.6% in June. Industrial production grew by more than double forecasts as output jumped 8.9% during the month following a sharp drop in May. Strong output of cars, electronic parts, and communications equipment drove the recovery in production, thanks to reduced lockdowns in China that lessened the supply disruptions. The au Jibun Bank Japan Manufacturing PMI slipped to a 10-month low of 52.1 in July as manufacturers signaled slower improvements in operating conditions. New orders fell at the fastest pace since November 2020, contributing to a renewed contraction in production. Japan was shocked by the tragic assignation of former Prime Minister Shinzo Abe, who was a potent political force within the Liberal Democratic Party.
Singapore (+5.4%) ended higher for the first time in four months. The central bank unexpectedly tightened monetary policy as the country’s key consumer price gauge rose at the fastest pace in more than 13 years. The tightening came after second-quarter GDP grew 4.8% year over year, below forecasts and unchanged from the previous quarter. While the broad reopening of Singapore’s economy revitalized the service and retail industries, a 0.9% contraction in trade and transportation and rising inflation dented sentiment. Core inflation jumped 4.4% year over year in June, the highest level in almost 14 years, increasing the likelihood of further monetary policy tightening this year.
Emerging markets (EM) equities (+0.2%) ended flat. Europe, the Middle East, and Africa (EMEA) and Latin America finished the month in positive territory, while Asian equities ended lower. Higher policy rates in several countries helped to ease recent currency pressures and support share prices.
EMEA equities (+4.5%) registered their first monthly gain since Russia’s invasion of Ukraine. Hungary (+5.6%) rose as the forint rebounded following a multi-month decline against major currencies. Government officials cited currency strength as essential to curbing inflation and preventing the current account deficit from dipping further into negative territory. Uncertainty about Russian energy supplies continued to weigh on highly energy-dependent economies like Hungary and the Czech Republic (0.8%), while energy supplies to countries such as Poland (+3.1%) were more stable, thanks to a multiyear investment in a gas pipeline from Norway. Turkey (+6.0%) generated good gains, signing an agreement to unblock Ukraine’s grain exports via seaports, which could help to ease global food shortages. South Africa (+2.0%) advanced amid more hawkish central bank plans to protect against import inflation and stabilize the country’s currency.
Latin American equities (+3.9%) realized solid returns. In Brazil (+4.9%), robust job creation and declining unemployment in June signaled that the economy remained strong despite very tight monetary policy. Peru (+3.0%), Colombia (+2.2%), and Mexico (+0.9%) rose as prospects for higher interest rates helped to support local currencies. Chile (+8.1%) led the region, benefiting from higher spot prices on lithium exports.
Asian equities (-0.8%) were dragged lower by China (-9.3%). Chinese stocks suffered from concerns about renewed lockdowns in Shanghai, weaker-than-expected second-quarter GDP, and dwindling confidence in the country’s property market. The number of home buyers refusing to pay mortgages for unfinished housing projects rapidly rose, increasing the risks of contagion to other parts of the financial system and prompting the State Council to mobilize up to US$148 billion of loans to help developers complete unfinished projects. China’s economy narrowly avoided contraction as its GDP grew at a lackluster 0.4% annual rate in the second quarter, below consensus estimates of 1.0%. All other Asian countries ended higher, led by India (+9.8%), where economic growth remained relatively strong amid mounting inflationary pressures. South Korea (+5.9%) generated above-forecast second-quarter GDP growth of 0.7% amid government support and as consumption remained sturdy despite higher prices. In Taiwan (+4.0%), equities rallied after officials pledged to support domestic companies via a stabilization fund, while an upcoming visit from the US House of Representatives Speaker Nancy Pelosi elevated tensions with China. Thailand’s (+2.1%) Prime Minister Prayut Chan-o-cha and 10 other cabinet members survived a no-confidence vote amid waning business activity. Philippines (+2.5%) President Ferdinand R. Marcos, Jr. announced a tax system overhaul and set a new long-term GDP growth target of 6.5% – 8.0% by 2028. The Philippine central bank surprised markets by hiking policy rates by 75 bps amid sustained and broadening inflation.
Most fixed income spread sectors recouped a portion of their year-to-date drawdowns and outperformed government bonds due to a decline in sovereign yields and narrower spreads. Heightened fears of a global recession were partially offset by expectations for slower monetary policy tightening by major central banks.
US economic data was mostly weaker, with second-quarter GDP contracting amid greater uncertainty about the trajectory of the US economy and recession fears. Consumer confidence dipped as business- and labor-market components remained subdued. Weekly jobless claims were higher, while nonfarm payrolls increased more than expected, driven by strong growth in the education and services sectors. The manufacturing PMI retreated as higher interest rates fueled anxiety around the economic outlook, while regional manufacturing indices generated mixed results. Industrial production contracted, underpinned by weak demand for consumer goods, and durable goods orders rose more than anticipated due to strong demand for military aircraft. The housing market stumbled; new-home sales plunged, and existing-home sales fell to a two-year low as surging borrowing costs continued to erode housing affordability. In Europe, a broader reopening of economies led to second-quarter GDP growth that exceeded expectations, although high inflation and energy shortages posed significant headwinds to economic growth. Germany’s Ifo Business Climate Index fell at the steepest pace in more than two years. Inflation in the UK rose to a 40-year high, driven by skyrocketing food and fuel prices. China’s second-quarter GDP growth fell short of consensus estimates, hindered by COVID lockdowns, while Japan’s CPI increased, amplified by higher energy prices. Canada’s economy was steady amid a rebound in services sector activity. In Australia, job growth was much stronger than expected and headline inflation rose to a 21-year high, far outpacing wage growth.
The Fed lifted interest rates by 75 bps, with Fed Chair Powell stating that the pace of future rate hikes will be dependent on incoming data. The Reserve Bank of Australia and the Reserve Bank of New Zealand both raised rates by 50 bps, and the Bank of Canada opted for a 100 bps increase. The ECB boosted rates by a greater-than-expected 50 bps and provided more details on its new anti-fragmentation tool.
Most global sovereign yields declined on recession fears, even as major central banks continued to front-load their rate-hiking cycles. The market’s marginally dovish interpretation of Fed Chair Powell’s comments, combined with a contraction in second-quarter US GDP, helped to push US Treasury yields lower. Yields in Europe, Australia, and Canada declined the most amid clearer signs of slowing global economic growth, while falling commodity prices garnered hopes that inflation would ease, and the pace of monetary tightening could slow. Japanese government bond yields slipped after the BOJ maintained accommodative policy even after it revised inflation projections higher. EM yields ended mixed. The Bloomberg TIPS index generated a total return of 4.35% and the 10-year breakeven inflation rate increased by 21 bps, to 2.55% during the month.
Global credit outperformed duration-equivalent government bonds as spreads tightened. Within the securitized sectors, agency mortgage-backed securities outperformed, commercial mortgage-backed securities were relatively neutral, and asset-backed securities underperformed duration-equivalent government bonds. Within EM, local markets debt (+0.29%) underperformed external debt (+2.89%) in US-dollar terms. Narrowing spreads contributed positively to results within external debt, and the movement of US Treasury yields also had a positive impact. The depreciation of EM currencies detracted from performance in local markets, while movement in EM rates helped results.
The US dollar was mixed, rallying versus most EM currencies but declining against most major developed market currencies. The Japanese yen generated the largest gain among G10 currencies; falling commodity prices, a dovish interpretation of comments by Fed Chair Powell, and a contraction in US GDP contributed to lower yield differentials between the US and Japan. Despite lower oil prices, the Norwegian krone advanced as a larger-than-expected increase in inflation fueled speculation that the central bank will accelerate the pace of its rate hikes. The euro declined on disappointing economic data, political uncertainty, and concerns about natural gas shortages, which prompted EU energy ministers to introduce voluntary curbs on gas consumption. Most EM currencies declined versus the US dollar, except for select trade and commodity-linked Latin American currencies (Brazilian real and Chilean peso).
Commodities (+0.0%) settled flat, with two of the four commodity sectors generating positive returns. Industrial metals (+0.7%) was the strongest-performing sector, driven by lead (+7.5%), as a greater risk appetite and a weaker US dollar helped to support prices. Zinc (+6.8%) and aluminum (+2.7%) advanced following new evidence that Europe’s energy crisis is putting smelters under pressure, with recent cutbacks contributing to extreme shortages in the region even as the demand outlook deteriorates. Nickel (+4.2%) gained on expectations of greater Chinese stimulus and as war between Russia and Ukraine disrupts supplies. Copper (-3.9%) fell as fears of a global recession continued to weigh on demand for the metal, which is seen as an economic bellwether due to its wide range of uses.
Energy (+0.3%) finished slightly higher, driven exclusively by US natural gas (+54.4%); intense heat across the US increased the need for cooling, which helped to absorb domestic gas supplies after the Freeport liquified natural gas (LNG) facility closed due to a fire. Gas oil (-0.3%), crude oil (-2.6%), and heating oil (-5.0%) ended lower as the market continued to weigh compelling fundamentals against a deteriorating outlook for global economic growth. Gasoline (-5.7%) also slumped amid concerns about the health of the global economy.
Agriculture and livestock (-1.1%) declined. Lean hogs (+11.9%) surged as strong prices allowed pork packers to offer higher cash prices for tight hog supplies. Live cattle (+4.0%) and feeder cattle (+3.3%) also generated solid returns. Soybeans (+0.9%) finished higher on concerns that North American oilseed crops could be hurt by hot and dry weather, which is forecast in August. Cocoa (-0.5%), coffee (-5.4%) and sugar (-5.0%) fell on recession fears and concerns that a strong US dollar may drive down prices. Cotton (-2.0%) declined as rain in some growing areas eased concerns about drought continuing to strain US supplies. Corn (-1.8%) and wheat (-8.3%) ended lower after US crop conditions were better than expected and as Ukraine prepared to gradually ramp up exports throttled by Russia’s invasion.
Precious metals (-2.2%) declined for the fourth straight month as silver (-0.6%) and gold (-2.3%) were pressured by strength in the US dollar and rising interest rates.
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