Sabco® Investment's Monthly Market Report - July, 2022

Sabco® Investment's Monthly Market Report - July, 2022

July 2022 witnessed a significant turnaround for equity markets, following a lacklustre first half, while bond yields experienced a sharp decline. Consequently, the euro faced weakening against most currencies.

Stock markets demonstrated their strongest monthly performance since November 2020, when the announcement of the first Covid vaccine was made. Multiple factors contributed to this rebound. While the Federal Reserve implemented a 75 basis points increase in its policy rate, it also signaled a potential slowdown in the pace of interest rate hikes if economic conditions require it. Additionally, the earnings season began on a positive note in both the U.S. and Europe, with several major companies exceeding expectations, particularly in the technology sector, although there were notable setbacks as well (e.g., Walmart). Growth stocks led the rally, a trend that remained consistent across the U.S. and Europe, with growth stocks outperforming value stocks by more than double, fuelled by lower interest rates and concerns over economic growth.

During this rebound, U.S. stock markets outperformed other regions, even when considering the dollar terms, partly due to the higher weightage of growth stocks in stock market indices. In Europe, confidence was affected by the gas and Italian political crises, but European stock markets still managed to deliver a solid performance. On the other hand, Chinese equities underperformed after a strong performance in previous months. The resurgence of Covid infections and associated lockdowns led to a downward revision of growth expectations, while risks in the Chinese real estate market became more pronounced. Construction projects faced financing challenges, and dissatisfied buyers began halting monthly instalments.

Bond yields continued their downward trajectory in July, which had initiated in mid-June. Apprehensions regarding excessive cooling of economic activity persisted in the market. U.S. 10-year yields dropped from 3.5% in mid-June to 2.65% by the end of July, while German 10-year yields fell from 1.75% to 0.85% over the same period. U.S. 10-year yields even fell below 2-year rates, leading some to view the inverted yield curve as a signal of an imminent recession.

The fall of the Draghi government and the ensuing political uncertainty widened the interest rate spread on Italian government bonds to 225 basis points by the end of July. Early elections were scheduled for September 25, and polls indicated a potential coalition of right-wing and far-right parties, raising concerns that the new Italian government might abandon fiscal discipline.

Euro corporate bond spreads, both in investment grade and high yield segments, narrowed slightly in July following their significant surge in recent months. Increased risk appetite in the market, coupled with higher interest rates, renewed investor interest in corporate bonds.

The Federal Reserve raised its key interest rate for the fourth consecutive time in 2022. The 75 basis points increase brought the range to 2.25-2.50%. This move was widely anticipated. Of greater importance, the Fed hinted at the possibility of future rate hikes occurring at a more moderate pace. This dovish stance was well-received by the markets. Market expectations for the remaining three meetings in the year indicate a 50 basis points increase in September, followed by 25 basis points each in November and December. Based on current projections, this would mark the conclusion of interest rate increases in this cycle.

The European Central Bank raised the deposit rate by 0.50%, signalling the end of the era of negative interest rates. Any future rate increase will depend on the economic situation's development and inflation levels. During the meeting, the ECB unveiled details of its new anti-fragmentation tool. One key aspect is the ability of the ECB to activate this instrument to purchase bonds from financially troubled countries. However, it should be noted that the significant deterioration in financing conditions must be unrelated to the country's macroeconomic fundamentals in question.

Furthermore, countries seeking assistance through this mechanism must meet various conditions, including compliance with EU fiscal rules, which are expected to be reinstated in the upcoming years after being suspended during the Covid period. However, the specific criteria the ECB will use to trigger this mechanism remain unclear at present.

The euro faced weakening against most other currencies, as the gas crisis heightened concerns about a potential recession later in the year, compounded by political turmoil in Italy, which undermined confidence. In mid-July, the euro briefly reached parity with the dollar. However, in the latter half of the month, the euro managed to recover some of its losses following the ECB's announcement of its new anti-fragmentation tool. Additionally, the Federal Reserve's more relaxed stance on future interest rate hikes contributed to a stronger euro and a weaker dollar at the end of the month.

Other major currencies, including the Australian dollar (AUD), Canadian dollar (CAD), and New Zealand dollar (NZD), also strengthened against the euro. The central banks of these three countries raised their policy rates during the month, with the Bank of Canada implementing a significant 100 basis points increase at once.

The Swiss franc continued to appreciate against the euro, becoming 2.8% more expensive during the month. Similarly, the Norwegian krone and Swedish krona strengthened against the euro, recording gains of 4.2% and 3.2%, respectively. Norway's higher-than-expected inflation rate in July opened the possibility for an accelerated pace of interest rate hikes.

Overall, emerging market currencies generally underperformed amid a strong dollar. However, there was some recovery in the second half of the month, except for the Turkish lira, which experienced further depreciation.

The Brent oil price briefly dropped below $100 per barrel during July, having reached a peak of $128 in March. Concerns about oil demand moderation in the event of a recession in Western economies continued to weigh on prices. However, by the end of the month, the price managed to recover somewhat.

The European gas price briefly dipped to 150 euros per MWh after Russia resumed gas supplies following maintenance work on the Nord Stream 1 pipeline. Subsequently, due to a further reduction in supply, the price rebounded to 200 euros per MWh, representing a one-third increase within a month.

Industrial raw material prices sustained their downward trajectory in July. For instance, the price of copper fell to $7,000 per ton in mid-July, compared to over $10,000 just three months prior. However, in the latter half of the month, the copper price experienced a partial recovery after several producers downgraded their production forecasts for the remainder of the year.

Gold continued to face challenges as the stronger dollar and higher short-term interest rates exerted downward pressure on its price. Moreover, improved overall investor risk appetite diluted the demand for safe-haven investments.