Equity markets climbed the wall of worry in July to help recover a great deal of the losses from an ugly June that saw many markets down 5-10%.
As much as anything else, the reason for this bounce really comes down to positioning. In June, investors lost faith in the ability of global central banks to control inflation without forcing the economy into a deep recession, and many funds had taken cash levels up. As a result, sentiment was sometimes touching extreme levels of negativity. The headlines and earnings didn’t need to come out perfectly for a bounce, it just had to come out better than feared. Which it did.
The last few weeks of July were incredibly busy for what is usually a slow time in the markets. Macro data was scoured for signs of a “peak” in inflation, corporate earnings calls were monitored to determine if analysts would have to slash their earnings estimates, and of course the Fed meeting was an important event to determine the path forward for the U.S. At the end of the month, we also got confirmation that the U.S. economy is in a technical recession, although on brand with these interesting times, that definition is being questioned and redefined.
After leaving pandemic spending policies on far too long, central bankers globally are coming to the realization that putting the inflation genie back in the bottle is tricky and will take years. This was highlighted by the 40-year high U.S. consumer price index (CPI) print of 9.1% during the month.
Given the difference between CPI and the U.S. Fed funds rate, it will be difficult to call for a pause in rate hikes until these lines get closer. To battle this, the Bank of Canada came out aggressively with a 100bp hike and the U.S. followed with their second 75 bp hike in a row. We even saw the European Central Bank join the hiking party.
A dream scenario for global central bankers and the market would be to see inflation begin to fall off in the second half of the year. We have already seen commodities—such as oil, copper, and lumber—fall, which should help this scenario. Inventories that were drained last year due to supply chain issues and pent-up demand are recovering, and companies are beginning to talk about price discounts to clear the channels. Maybe a portion of the spike in inflation was “transitory” all along…the second half of the year will test that theory.
Corporate earnings have been mixed, but they are coming in better than feared. For every Walmart, which had to guide lower because of inventory management, there was an Amazon, which beat expectations and signalled confidence in their business model. One of the tricks in investing is predicting the expectations of others. Over the last few weeks, the bar has been incredibly low, and we are seeing companies clear that hurdle and be rewarded.
But we may not be out of the woods yet. Markets have seen a nice rebound, but the months of August and September can be challenging for equity markets. Once again, every data point is important for signals of a peak in inflation; the last FOMC comments have signalled they are becoming more data-dependent and willing to adjust course if the data allows for it. This may also be a case of bad news being good for markets and it could again give cover for a less hawkish tilt.
Unfortunately, markets remain beholden to the actions of central bankers. We have all learned not to fight the Fed. A signal of them becoming more balanced by the fall could set off a nice rally into year end, as those who had been sitting on the sidelines come back to the markets. But to get there we need a lot of things to play out first.
Low volume summer markets can be difficult to time, but we may be close to a near-term low and pullback, which could present great opportunities for underweight investors to begin to reallocate to risk assets for a bounce.
— Greg Taylor is the Chief Investment Officer at Purpose Investments
Sources: Charts are sourced to Bloomberg L.P.
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