US CPI beats economists' expectations
The most anticipated economic release of the week (and of the month) turned out to be simultaneously shocking and monotonous. The US Consumer Price Index for June came out at 9.1% Year-on-Year increase, much higher than the 8.8% growth predicted by economists. All the inflation warning lights were flashing as CPI increased by 1.3% from a month earlier (vs.1.1% expected) and even core-CPI, which strips out food and energy, rose by5.9% YoY and 0.7% from May, again higher than expected. A similar set of above-expectations CPI numbers last month had caused equity markets to crash by circa 10%, yet the response this time around was extremely muted. The S&P500 lost about 1% and the yield on 10-Year US Treasury Bond barely moved up. It appears that for the time being, markets have factored in sustained high inflation and rising interest rates and are starting to focus on what comes next.
Returns for the week were overall quite muted, with Japan outperforming all major markets at +1.1% and the laggard being Emerging Markets at -3.7%. I was as if markets in Australia (-1.1%), Europe (-0.8%), UK (-0.5%) and the US(-0.9%) were all waiting for the US earnings season to kick in earnest this week.
The quiet in equity markets wasn’t matched in currency land, where the Euro fell to a grim milestone of parity with the US dollar, a level last reached almost 20 years ago. Since its peak in mid-2021, the Euro has fallen by nearly 20% vs. the USD, which actually says just as much about the strength of the USD then the weakness of the Euro. The change is in part due to the more aggressive stance of the US Federal Reserve, which has already raised its cash rate 3 times this year by a cumulative 1.5% and is expected to raise it by 0.75%at its next meeting. By contrast, the European Central Bank will most likely raise its benchmark for the first time this year, by an expected 0.25%. As in Australia, the effect of a weaker currency in Europe is a double-edged sword: it helps support exports but also increases inflation pressures.
At a sector level across the globe, returns were likewise mostly negative but mildly so. Materials (-3.5%) and Energy (-3.4%) led the way down, potentially underscoring growing fears of an economic slowdown, but Financials (-2.4%) and perhaps more surprisingly Communication Services (-2.9%) didn’t perform much better. Only Healthcare (-0.3%) and Consumer Staples (unchanged) managed to stay mostly out of trouble. The performance of iron ore producers such as BHP(-9.0%) and Vale (-11.0%) and oil companies such as Chevron (-3.6%) and Shell(-4%) is indeed consistent with the perceived growing likelihood of a recession. As is the relative outperformance of companies with lower economic sensitivity such as bulk retailer Costco (+4.3%) and “big pharma” Novo Nordisk(+3.8%). But it was the performance of the famed FANMAG that failed to follow the usual script. While Apple (+2.1%) led other “quality/growth” companies like Visa (+3.2%) and Mastercard (+2.9%) on the well-trodden paths of 2019 and 2021,Microsoft (-4.1%), Alphabet/Google (-6.2%) and Meta/Facebook (-3.6%) took a different turn. In the case of the latter two, it is likely that advertising, their primary source of revenue, is seen as very vulnerable to a recession.
Apart from CPI and the EUR, the other consequential news of the week came from China, where GDP growth disappointed at only 0.4% for the June quarter. While a string of lock downs since the beginning of the year partially explains the sluggish growth, worries about debt levels seem to play a part as well, with the Chinese Real Estate sector down -15.3% for the week. China’s tech champions were not immune, with Baidu (-8.5%), Tencent (-7.9%) and Alibaba(-15.6%) retracing their June gains.
The Australian market mirrored its US counterpart to a large extent, with the mining sector leading the way down (Rio -4.3%, Fortescue -5.6%,South32 -8.6%). Companies that were mostly known as “growth marker darling” are starting to suffer not just from the higher interest rates but increasingly from their high economic sensitivity (James Hardie -4.1%, Carsales -5.2%,Domino’s -5.8%), in stark contrast to the likes of CSL (+4.1%), Cochlear (+6.2%)and Telstra (+2.1%). Positive returns also came from one of the most unexpected corners of our market, with coal producers Whitehaven (+11.5%), New Hope(+16.1%) and Coronado (+10.3%) showing that for now at least, supply and demand dynamics trump environmental considerations.
