The week in review

What’s happened in markets?

The week of 18 July saw no let-up in market volatility. Economic data remained fairly negative overall, coming in below economists’ expectations, as high inflation and steepening borrowing costs continued to fuel recessionary fears.

In the US, home builder sentiment tumbled as the National Association of Home Builders (NAHB) Market Index fell for a seventh straight month to 55 in July. This was below the expected decline to 65 and the lowest reading for the index since May 2020, indicating a softening of the housing market. US purchasing manager’s indices (PMI) were also weaker than expected signalling a contraction in business activity (a reading of below 50) for the first time in nearly two years. The S&P Global US composite PMI fell to 47.5 in July from 52.3 in June. Manufacturing activity showed some signs of growth but at a very weak pace, down to 52.3 in July from 52.7, but the services sector saw the sharpest fall to 47.0 in July from 52.7 in June.

In the UK, consumer price index data came in stronger than expected in June at 9.4%, another 40-year high. The Bank of England governor, Andrew Bailey, indicated that a 50 basis point interest rate hike could be considered in its August meeting. The remarks reflected Bailey’s earlier pledge to act forcefully to tackle inflation and bring it down to the 2% target.

In the EU, business activity contracted to a 17-month low with the S&P Global eurozone composite PMI falling to 49.4 in July from 52.0 in June. Manufacturing activity fell more than expected to 49.6 as factories were hit by falling orders and rising prices. There was also political upheaval in Rome as Italian prime minister Maria Draghi resigned and triggered a snap election due to be held on 25 September, after the three main political parties boycotted a confidence vote. The European Central Bank (ECB) already faces a difficult path between responding to inflation and avoiding recession in the region. The bloc is facing more uncertainty over the surging food and energy prices resulting from Russia’s invasion of Ukraine, and the potential weaponising of Russia’s natural gas supplies ahead of winter.

The ECB raised its rates for the first time since 2011 as eurozone inflation hit a record high of 8.6%. The 50 basis point rise was larger than expected and ended eight years of negative rates to take the ECB base rate to zero. The ECB also unveiled its transmission protection instrument (TPI), an anti-fragmentation bond-buying programme to assist more vulnerable eurozone countries that might be negatively affected by its interest rate policy.

In corporate news, results were down on previous quarters but still beat revised expectations. Goldman Sachs and Bank of America both performed well, with higher interest rates bolstering results for financials. Goldman Sachs also benefited from the high volatility with their fixed income trading desk contributing to performance. Netflix also beat expectations by losing fewer subscribers than feared.

The main positive news for the week of 18 July was the resumption of gas supplies through the Nord Stream pipeline at 40% of capacity, as its scheduled maintenance ended. But Putin still has the power to turn off the tap if he chooses to. On 22 July, Russia and Ukraine signed a UN-brokered deal to alleviate the growing global food crisis by allowing grain exports to resume via the Black Sea. However, less than 24 hours after the agreement was signed, Russian missiles hit the critical Ukrainian port of Odessa.

Markets were more buoyant over the week of 18 July and for the month as earning results came in better than expected. Growth (+7.2%) was the outperforming style compared to value (+1.1%). Developed markets (+4.8%) significantly outperformed emerging markets (-1.9%) in the short term. Small capitalisation stocks (+4.6%) and large capitalisation stocks (+4.1%) had broadly similar performance.

In sector terms, information technology (+8.1%) was the best 30-day performer and energy (-5.7%) the worst, due to the weakening of the oil price following the huge gains of the previous six months. Commodities continued to struggle in the face of recessionary fears and trended down over the last 30 days, with gold at -6.8% and oil -10.1%.

Bonds have been well supported on the back of falling yields. With rallies in quality within government bonds and, more recently, euro bonds, despite the ECB rate hike and the Italian elections. But bond yields remain extremely volatile on a daily basis as markets look to price in either inflationary or recessionary pressures.

In terms of currencies, US dollar strength continued against other major currencies due to its safe haven status.

What’s happened in portfolios?

There has been no significant change on the week in terms of portfolio themes, although within asset classes we have changed some positions.

Faced with a challenging environment for equities and clear headwinds, we feel it is a good time to lock in the relative gains from our value position and tilt our equity positioning towards quality focused strategies. With a potential slowdown in global growth and recessionary fears entering the market, investors are looking to those companies that are less cyclical, more cash generative, and tend to have better margins, which should enable them to weather any storms. The US market has also led the pack on a month-to-date basis, partly due to strong corporate earnings but also because the US tends to outperform the UK and Europe in recessionary environments.

The significant upward shift in yields has made fixed income more attractive. The current environment is less supportive for credit, and we have reduced our overweight to high yield and rotated into higher quality investment grade and government bonds, which have been an outperformer given recessionary fears. At the same time, we have incrementally increased duration as yields move higher.

In terms of real assets, we have seen some bifurcation with the open-ended funds being impacted more by the general market uncertainty and risk-off environment, given their higher market beta, while the closed-ended funds have held up better. Overall, real assets have performed well for portfolios on a year-to-date basis.

Within alternative strategies, energy efficiency funds and battery storage are relatively new additions to the portfolio but are holding up well. This is due to the stability of the asset class, which is supported by the structural tailwinds of the green energy revolution and the transition to net-zero, meaning they are less cyclical in nature and less influenced by the current market movements. Although the battery storage holdings have benefited from the energy price volatility by taking advantage of arbitrage strategies – to buy energy when the price is low and sell it when it’s high. This has generated income and performed well to date, along with providing diversification to the portfolios.

What’s happening this week?

25 July • UK CBI Business Optimism Index (Q3) | 27 July • US Federal Reserve Interest Rate Decision | 29 July • EU Gross Domestic Product Growth Rate