Markets were fairly soft all week, but the real action happened just after the European close when Gazprom announced it would not reopen the Nord Stream 1 pipeline, which had been closed for maintenance due to ‘malfunctions’. The market had previously risen after a particularly positive jobs report but ended the week down over 3% in the US while other markets were down around 2%. Some of this heightened volatility can be put down to low liquidity ahead off the US Labour Day long weekend, but it also points to the market’s biggest pain point - a strong US economy has been bad for markets as it implies higher interest rates, but high inflation due to high energy prices is worse still, as it may herald both economic weakness and the higher rates required to reduce inflation. High growth stocks trading on a relatively high price/earnings multiple with a higher proportion of their economic value accruing in the longer run have been particularly sensitive to interest rates this year, and the so-called discount rate effect was very much still the dominant effect last week, as tech stocks such as Apple, Microsoft, Nvidia, Tesla and Amazon all bore the brunt of the selling. An unwelcome irony of this situation was that Gazprom (still in the MSCI All Countries Index) was the single largest positive contributor to stock markets after jumping more than 30% on record profits reported last week. Lukoil, the Russian oil company, was also amongst the strongest contributors, the same week its chairman – who had criticised the Ukraine invasion – ‘fell’ out of a window.

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The Australian market was also 3% in the red, mostly due to the large miners which were down around 10% on news of Chinese lockdowns, as well as a relatively disappointing result from Fortescue.  Most other sectors were also down, as a generally strong earnings season drew to a close, with forward guidance from companies being notably mute.

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That all contributed to a weak August, which had started well but ended with US and European markets down around 5%, and the UK and Australia down by 2%. Japan was the best performer, down by just 1%. Around the middle of the month, the strength of the US economy (and the interest rate levels that this implied) had already weighed on markets, but later in the month it was Jerome Powell’s Jackson Hole speech that confirmed the down trend in markets. The Federal Reserve has now made it very clear that a rate induced recession that ‘the US has to have’ is now very likely, unless there is a dramatic fall in inflation. Given the strength of the US Dollar (typically a harbinger of doom for less developed markets) emerging markets have been remarkably resilient in recent months. Even the embattled Chinese market ended the month in positive territory, while many Latin American markets posted returns in the mid-single digits(Brazil) or double digits (Argentina).

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As one might expect, with fears of a looming recession and a Fed that is unwilling or now unable to prevent it, credit spreads pushed out further and last week saw a meaningful rise of almost 0.5% in high yield spreads. This capped another bad month for bonds, most of which lost more than normally riskier equities in August. High yield bonds and government bonds both fell by similar amounts(4-5%) because many high yield bonds that carry more credit risk tend to pay floating rate coupons, while most government bonds have fixed coupons and are more sensitive to interest rate changes. This is also why investment veterans of the seventies say that there is nowhere to hide in a stagflationary economy. On a slightly brighter note, most of the diversified bond funds that have become popular in Australia – which tend to be biased to very high quality local floating rate bonds – performed well in August, and many were actually in positive territory.              

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