World markets summary:
July was a good month for investors as the mood was buoyed by positive developments on both the inflation and profit front as well as increased stimulus hopes in China. Commodities, property, equities and bonds all advanced during July, with the notable exception of the Nikkei 225 equity index in Japan. Japanese shares had been strong in previous months and the decision by the Bank of Japan to reduce the control it has over bond yields gave investors an excuse to pause buying.
Asia (excluding Japan) equities performed best geographically on the potential for more supportive policy in China as mentioned above, but advances were widespread across the region. It should be noted that official communiques have stressed that Chinese authorities now want to support the private sector. This is likely to be good for investors. The Nasdaq continued its strong run and, like the S&P 500, rose for the fifth consecutive month.
Despite continued muted economic activity, European shares joined the rally with Italy showing particular strength. The UK, especially the FTSE 250, joined the party as investors at last got an inkling that our inflation, and therefore interest rate woes, could nearly be over.
Commodities were the strongest performing sector, supported by China policy hopes and a weaker US dollar.
Across regions, corporate profits have generally pleased market participants and this has led to increased talk of a ‘Goldilocks scenario’, where economic growth is not so weak that it hinders corporate profits but not so strong that we have to incur interest rate rises. In our analysis, only emerging markets are close to having felt the full impact of prior monetary policy tightening so we will need to be alert to any complacency in the market. However, we hold overweight positions in areas such as short duration bonds, UK equities and Asian equities, which we believe still provide attractive risk reward. Certainly, within these equity areas there is an absence of enthusiasm however both UK equities and short duration bonds provide excellent yield support.
Our in-depth views on:
Our weightings are based on sterling as a base currency.
United Kingdom (UK)
UK shares enjoyed their best month since January 2023 as the inflation release came in below expectations for the first time in four months. This gave particular relief to companies related to the property sector, including house builders and commercial landlords. The increase in optimism enabled small and mid-capitalisation companies to rise by even more than the FTSE 100, and cyclical stocks also performed well.
The Bank of England’s Governor, Andrew Bailey, stated that he envisaged inflation coming down ‘markedly’, a view we have expressed for some time.
The prospect of peaking interest rates enabled investors to look through some weak economic releases. For example, a composite Purchasing Managers Index and Industrial Production numbers that both came in below expectations, and the fact that actual two-year fixed mortgage rates hit a 15-year high. As has been the case for a while, wage growth actually exceeded expectations.
Another supporting factor for UK equities in July was the generally decent profit-reporting season. For example, Unilever, NatWest, Rolls Royce, Lloyds and Standard Chartered all produced very solid profits and the banks backed this up with share buybacks and healthy dividends.
The full impact of all prior interest rate rises is still to hit the economy and there are likely one or two interest rate rises left before the hiking cycle is over. However, markets are forward looking and peak rates are already in sight. This, combined with historically attractive valuations, should provide investors with optimism over the medium-term.
United States (US)
The inflation picture has continued to improve in the US with the headline Consumer Price Index (CPI) number coming in at 3% early in July and the Federal Reserve’s (Fed) favoured Core Personal Consumption Expenditures (PCE) price index number coming in at the lowest level since September 2021, as well as producer prices easing. As a result, the Fed again raised interest rates with many investors now expecting the US to be at the end of the rate hiking cycle. The biggest risk to this disinflation trend we are seeing unfold is commodity inflation re-emerging with commodities up over 10% in July. This is something we will continue to monitor closely.
Elsewhere, economic data has been mixed with manufacturing continuing to be weak. We are now seeing a cooling in the labour market while services have continued to hold up. This was also seen in the second quarter’s (Q2) gross domestic product (GDP) growth number which came in much stronger than expected.
This stronger GDP growth appeared to be reflected in Q2 company earnings releases in July with earnings generally better than expected. Alphabet and Meta’s stock results helped the Nasdaq achieve its longest outperformance run in the last three years. However, there were some signs of weakness, for example, Texas Instruments in the semiconductor sector and also in the technology sector Microsoft’s Cloud business slowed. We have seen some weakness in the forward guidance in sectors such as energy and materials while the technology sector has generally been better than expected.
Europe
European markets outperformed US peers in July as we saw a broadening out of the rally into cyclical stocks as sectors that had thus far struggled this year, namely energy and materials, performed well.
As expected, the annual inflation rate in the Eurozone slowed for a third consecutive month, due to a further drop in energy prices, however services inflation again increased. As a result, the European Central Bank (ECB) raised interest rates by 0.25%, however ECB President, Christine Lagarde, was much more dovish in in her press conference and as a result, some market participants are now no longer expecting another rate rise in the September 2023 meeting. Some are now speculating that the ECB may be the first to cut interest rates on the back of the weaker economic data that came out in July compared to other developed market peers.
On this weaker data, Eurozone Purchasing Manager’s Indices (PMI) have continued to fall to new lows, especially in manufacturing as a result of the slower than expected rebound in China, while excessive temperatures have started to hit some areas of tourism. There were some shades of good news in German consumer confidence, which rose on hopes of inflation continuing to fall but it is still deeply negative. The Eurozone economy also grew more than expected in Q2, while unemployment remained at a record low, continuing to point to tightness in the labour market.
Asia and Emerging Markets
The Asian market experienced steady growth driven by the anticipated end to the US interest rate cycle, a weaker US dollar compared to June and optimism surrounding China’s stimulus plan after the Politburo meeting. US-China tensions remained stable with slight signs of improvement following the Association of Southeast Asian Nations (ASEAN) meeting.
Hong Kong stocks surged 4.8% as China pledged support for the property market and large internet companies. Mainland Chinese stocks rose 2.08% despite four consecutive months of Manufacturing PMI contraction, thanks to optimism over forthcoming stimulus measures. The Nikkei 225 fell slightly as the Bank of Japan maintained rates but adjusted its stance on Yield Curve Control, a monetary policy action which sees a central bank purchase variable amounts of government bonds or other financial assets in order to target interest rates at a certain level.
We are constructive on the region’s prospects with an expected easing cycle and China’s upcoming stimulus in response to disappointing Q2 GDP growth. Additionally, India actively entices companies like Tesla, Advanced Micro Devices (AMD), and Micron to build factories, while Thailand’s ongoing election sparks hope for democracy and policy improvements.
Fixed Income
It was another eventful month for fixed income investors. Firstly, in reality the Bank of Japan ended its multi-year practise of Yield Curve Control by which it intervened to ensure 10-year bond yields never exceeded 0.5%. It moved the band up to 1%, causing the yield to increase from 0.4% to 0.6% over the month. Elsewhere, the UK saw 10-year government bond yields fall, even as US and German interest rates rose by at least 0.10%. This was because UK inflation came in lower than expected for the first time in four months whereas US and European inflation had already been more benign. In both countries two-year government bond yields fell as investors embraced the prospect of peak interest rates in the second half of 2023, even if there are one, or possibly two, more increases to come before that occurs. Chinese 10-year bond yields were virtually unchanged in the period amidst sluggish economic growth and targeted policy easing by authorities. Investors appear to want, and expect, more easing from the Chinese authorities.
With a more optimistic tone to markets, corporate bonds produced positive returns and outperformed their sovereign counterparts although investment grade bonds slightly outperformed high yield bonds.
Across the Western World long-term government bonds still yield significantly less than short-term bonds (i.e. the yield curve is inverted). This leads us to believe the more attractive risk reward remains with short-term bonds, as although we are likely to make less money when (if) rates fall, there is far less risk and volatility attached to shorter-term bonds. Therefore, we are comfortable making this trade off on behalf of clients.
Alternatives
Commodities as a whole had a very strong month bouncing back from the trough at the end of June. Oil was no exception, registering the strongest month of performance since January 2022, with a 14% rise in July taking the price of Brent Crude to just over $85 per barrel. The strength in oil resulted from the anticipation of peaking US interest rates in conjunction with record high demand and tight supply. Both the Organisation of the Petroleum Exporting Countries (OPEC+) and Saudi Arabia have shown their intent on limiting supply, with expectations for Saudi Arabia to prolong their supply cut of one million barrels per day beyond August 2023. Both the International Energy Agency (IEA) and OPEC+ expect oil inventories to fall by 400,000-500,000 barrels per day this year. Therefore, the oil price will likely see further support going forward and Goldman Sachs have maintained their forecast of $93 per barrel for year-end.
Despite gold typically being utilised as a safe haven and historically having a negative correlation with real interest rates1, gold followed July’s commodity surge in the face of cooling inflation. The precious metal rose 4% to finish the month above $2,000. Gold also being used as a store of value appears to have played its part in this performance. Since the Turkish election, the lira has continued to reach record lows and Turkish millionaires have supported gold prices by utilising gold as a store of value. Currently, we are also seeing a slowdown. In the past, slowdowns have seen the correlation between real interest rates and gold prices turn positive. This could extend this period of strong performance, but the absence of income associated with gold at a time when income is particularly appealing will likely provide a cap on prices.
Property
UK house prices fell 3.8% in July on a yearly basis, which was a slightly deeper decline than the 3.5% drop witnessed in June2. High mortgage rates continued to provide the deterrent for home purchases and the average cost of a home now sits at £261,000. Tenants are also feeling the impact of higher mortgage rates after rental prices rose a record 5.1% in the 12 months to June. Multiple mortgage lenders announced cuts to mortgage rates towards the end of July, which may help to reduce the pace of house price decline going forward. However, the decline is unlikely to be thwarted anytime soon, as mortgage rates remain above those seen during the UK 2022 mini budget.
In China, new home sales fell 33% in July on a yearly basis, providing a further motive for the government to provide stimulus, given that the property market represents around 25% of China’s economy.
1Real Interest rates are adjusted for inflation.
2Nationwide House Price Index, 31 July 2023
Important Information
All Index data figures are sourced by Morningstar and correct as at 31 July 2023 unless otherwise stated.
The value of investments or any income arising from them may fluctuate and are not guaranteed. Past performance is not necessarily a guide to future performance.