Markets capped off a strong month with an even stronger week, with the leading US market up 4%for the week and 9% of for the month. The US earnings season has surprised weak expectations (especially for large tech stocks) and the Nasdaq performed even better. However, once again it seems that inflation and interest rate expectations were the real driver as weak economic data gave investors some 'hope’ that the Federal Reserve was seeing some early success in slowing the US economy and might be able to pause interest rate rises, including a second consecutive quarter of economic contraction (something which some, not all, call a recession). On the other hand, inflation measures, including the Fed’s preferred Personal Consumption Expenditures continued to rise (The PCE is abroad ‘core’ measure of inflation based on actual economic activity rather than surveys and notional baskets as is the case with the Consumer Price Index). In absolute terms it is, as usual, a little lower than CPI (6.9% for the last 12months and 4.8% excluding food and energy) but the direction of travel remains upwards on a monthly basis. What matters to markets though is what the net impact on bond rates is. Long bond rates have moved down by about 0.5% in the last month and fell again sharply last week. Fed Chair Jay Powell seemed to intimate last week that, rather than being on an inflation fighting crusade, the Fed would now be ‘data dependent’, implying that they would pause as soon as the data allowed them to.   Longer-term inflation expectations actually ticked up meaning that real (after inflation) borrowing rates moved back closer to negative territory. Overall, markets seem to be happier about the prospect of a return to the free money era than they are worried about recession. This month is also being hailed as the best month for markets since March 2020sounds a bit like turning point, although if you ignore month end distinctions we have already had 2 similar ‘bear market rallies’ so far this year.  It could be a turning point but for now it still looks like volatility and, as Powell was at pains to point out, we are all data dependent and the data is noisier than it has ever been due to the unprecedented COVID stimulus and its aftermath.

All that meant that the US tech giants led the market and made the biggest contribution, while perhaps surprisingly, UK, European and Australian markets kept pace last week while Asia and Japan were flat. For the month as a whole Japan and Australia almost kept up with the US while Europe was flat and Emerging markets were down a few percent. In the latter case the continued strength of the US Dollar has weighed on sentiment and into the end of the month concerns focused particularly on the debt laden property sector and a potentially deepening recession.  Australia’s banks also enjoyed a 10% bounce in July, perhaps cementing the notion in investor’s minds that local banks fortunes are more leveraged to the fortunes of indebted mortgagees than interest rate margins. Banks usually become more profitable in a rising interest rate environment - they themselves borrow at lower short-term rates and lend at usually higher long-term rates, except when near-term inflation plus fears of a recession lead to an inverted yield curve.  The yield curve is inverted when long-term rates are uncharacteristically lower than short-term rates, usually because the market believes rates will have to be lower in the future due to an imminent recession (and hence why an inverted yield curve is seen as predictor or recessions). Healthcare, Real Estate Trusts, Consumer Discretionary and IT stocks also rose by a similar amount with interest rates gain being a plausible driver in most cases.

The about turn we have seen in bond markets recently has also rippled through just about every asset class from bonds to equities and even quantitative alternative strategies, as well as to the fortunes of every active strategy within those asset classes. Bond managers who have so far suffered from exposure to interest-rate-sensitive government bonds were now up 3-4% while trend followers who caught the commodities boom earlier in the year were down by 3-4%.   In equities growth managers that were down20-50% this year got a welcome 5-7% bounce while many value managers that had endured minimal losses this year found themselves down a few percent last month. It seems that everyone in the money management world is going to have a keen interest in the question du jour - was July another ‘bear market rally’ or a turning point in sentiment. We’ll keep you posted on how this debate develops over the next few weeks.  

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