Investment Comment
29th July 2022
Easing on the brakes
Not a day goes by without a plethora of economic data being released for analysts to pore over and there is always the danger of being distracted by the noise and failing to see the wood for the trees. However, there are always key releases to review and this week we had a much-anticipated rate announcement from the US Federal Reserve (Fed) and an estimate of US economic growth for the second quarter. As the world’s biggest economy and with the US Dollar as the worlds reserve currency, the US is the key to market outcomes.
Data on Thursday showed the US economy shrank for a second consecutive quarter, driven by a sharp decline in inventory levels and reduced investment levels. Personal consumption remained strong albeit supported by reduced saving and increased use of credit to offset the squeeze in real incomes. Two successive declines in economic output is a common criteria for a technical recession and complicates the Federal Reserve’s push to stamp out soaring inflation with a string of aggressive rate rises. However, other economic data remains much stronger, notably the jobs market, and as the inventory overhang passes (a consequence of companies reacting to supply disruptions) growth should recover.
The Fed this week raised its main funds rate by 75 basis points for the second month in a row, taking it into a range of 2.25% to 2.5%. The increase was widely expected, and investors were encouraged as Fed chair Jay Powell said that the central bank may soon slow the pace of further rises.
“At some point it will be appropriate to slow down . . . We might do another unusually large increase [in September] but that’s not a decision that we’ve made at all, we’re going to be guided by the data,” he said.
Investors took Powell’s suggestion that monetary policy decisions would be data-dependent to indicate a lower probability of large rate rises going forward. This along with the disappointing GDP data further pushed down expectations for Fed rate rises for the remainder of this year, with the expectation that they will start cutting rates early next year. This led to an easing of bond yields and helped support equity markets that have been spooked by the aggressive rate rises.
Earnings watch
Second quarter earnings season is in full flow and so far, with around half of S&P 500 companies having reported, results have been solid with 73% of companies beating expectations. Revenue growth for the S&P 500 has been strong at nearly 10% but with margin pressure reported earnings are growing at a lower rate, around 5%. This week well received results from tech bellwethers, Microsoft, Apple, Amazon and Google parent Alphabet, who all issued more confident outlooks than investors had feared, helped lift markets. As sizeable constituents of the market they have an outsized impact on market moves.
July sunshine
After the gloom of the first half where there are few places to hide, equity markets have been buoyant through July and are headed for their best month since late 2020. Markets got very oversold in June as investor positioning became very negative and a combination of robust earnings and expectations that central bank rate rises may not be as aggressive as feared has led to the rebound.
Sustained equity market progress from here will continue to depend on the outlook of policy and profits. We believe that there are signs of a peak in inflation pressure (at least in the US) and economic growth is clearly slowing, which should lead to central banks easing the pace of monetary policy tightening, albeit there is a risk that markets have become too optimistic on the path for interest rates. Corporate earnings appear to be resilient despite the inflationary impact on household spending. Forecasts may prove too optimistic as economic growth slows but valuations have become significantly cheaper through the year and to some extent already discount a slowdown.
We remain cautiously positive on equity markets and continue to prefer equities to bonds. In our portfolios, we retain a preference for Emerging Markets Asia, attracted by the combination of valuations and supportive economic policy stance from the Chinese government, in contrast with tightening conditions elsewhere.
Gareth Thomas, CFA Head of Investment Management
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