US Fed Rate Hike Stimulates Equity And Bond Rally

Market Update 29th July 2022

This week we saw the US enter a recession that is not quite a recession yet. US GDP unexpectedly shrank in the second quarter by 0.9%, after falling 1.6% in the first three months of the year. Two quarters of declining GDP is usually enough to qualify as a recession, but for the US economy to officially qualify needs a ruling by the National Bureau of Economic Research. If it walks like a duck and quacks like a duck then we’ll have to check with our experts whether or not it is a duck and get back to you…….word just in, it is a duck!

There are some positives to take from the US though, as the jobs market remains strong and consumer spending is robust. However, the strong rally in US equities since we invested back into US Equities and global equity markets from 1^st July having avoided the significant falls this year prior to July, and the rally in government bonds this week suggests that a full-blown recession and a reversal of Fed policy is becoming the consensus view of markets, even if may take a while for the experts to concur.

Elsewhere, China’s leaders failed to come up with any new policies to deal with the country’s growing problems. Covid, slow economic growth and a struggling property market are just some of the issues that face China as President Xi lines up a historic third term as president this autumn.

In the UK there’s the continuing drama of the Conservative Party leadership contest with many pundits speculating that Liz Truss is opening up daylight between herself and ex-Chancellor Rishi Sunik who is seen to be increasingly out of touch with ordinary people. The question on many people’s minds is; is it worth the blue on blue in-fighting and waiting until September 5th to decide the new PM, or should one candidate admit defeat earlier so a new leader can be installed and the government get back to governing the country and dealing with the multitude of problems we currently face. 

  GLOBAL: COMPANIES STRUGGLE TO PASS ON THE COSTS OF INFLATION

Shares in US retailer Walmart fell sharply after it issued a second profit warning in 10 weeks. The company said revenue will fall as it is forced to cut prices to offload stock as it over ordered after being caught with too little stock as it emerged from Covid restrictions. Other companies which are unable to pass on price increases are feeling the effect. In the UK, fashion retailer Asos, medical equipment maker Smith & Nephew and FeverTree have all recently warned that falling margins will impact on profits. If you would like advice on your investments, find out more on our stockbroking page.

Meanwhile, companies which are able to pass on cost increases are increasingly doing so. This week McDonalds announced an increase of up to 20% on some items and Amazon has increased the cost of its Prime next-day delivery service by an average of 31% in its main European markets. Both companies reported rising prices are having little impact on sales. Unilever reported that its premium brands have allowed it to increase prices by an average of 11% without harming sales volumes.

 

US: FED MAINTAINS AGGRESSIVE RATE RISES TO COMBAT INFLATION

The US Federal Reserve raised rates by 0.75% for the second month in a row as it continues to take steps to tackle rising prices. Although the US jobs market remains strong there are some signs that the economy is beginning to slow and the US has just entered a technical recession as GDP fell in the second quarter of the year. US equities and government bonds both rallied strongly after the decision was announced. Fed chair Jerome Powell indicated he expects rates to increase by 0.75% at the next meeting in September before potentially moderating the rate of increase depending on economic data.

The International Monetary Fund warned that the global economy is teetering on the edge of a recession, with war in Ukraine, Covid and inflation among the risks. The yield on short-dated US and UK government bonds remains higher than the yield on longer-dated bonds, which suggests that markets are much more certain about a slowdown and that it will be severe enough for central banks to begin unwinding their recent rate hikes.

  CHINA: ECONOMIC WOES MOUNT AS XI SEEKS THIRD TERM

China is facing growing problems as the country falls behind its target of 5.5% growth in GDP this year. Perhaps the biggest issue is the country’s embattled property sector which is mired in debt. The central bank is preparing to raise $148bn of funding to kickstart the construction of millions of unfinished homes. Sales and new mortgage applications have fallen sharply and a rising number of people have stopped paying mortgages on unfinished properties.

Chinese consumer borrowing has slowed sharply, while youth unemployment hit a record high of almost 20% and China’s zero-Covid policy remains a problem as only this week over a million people were locked down in Wuhan because of the discovery of just 4 asymptomatic cases during routine testing. This week the Politburo, China’s top decision-making body, backed President Xi’s zero Covid policy but these tiny outbreaks remain a threat to growth. Unlike its last meeting, the Politburo made no explicit mention of China’s official growth target as economic issues were downplayed in advance of the Party Congress this autumn where Xi will seek an unprecedented third term as president.

In summary, our view remains that this is a time for active investment strategies, and we expect the recent gains of up to 10% across the Nasdaq, and similarly decent rises across the S&P, the Nikkei 225, the EuroStoxx 50, the DAX, and the FTSE-250 since 1^st July following a very poor preceding 3 to 6 months, – to fall back a bit in the coming weeks as the interest rate hikes start to bite into consumer confidence further, as the US recognises a recession when it sees one, and as energy and food inflation remain unpalatably high. We may look to sell down some of out holdings to bank these recent healthy profits, and then wait for the markets to move backwards before reinvesting to the extent that we are currently invested.  As we have said since the beginning of the year, and following our de-risking since the end of the summer 2021, we need to try to make and take short term profits and g against the grain of the lazy, benchmark tracking majority of just staying close to fully invested at all times.  That was an excellent strategy up until the financial crisis of 2008 / 2009, – but it is rather outdated.

When you consider that “modern portfolio theory” (which is still referred to as such within the investment management industry today), was created by Harry Markovitz during the 1950’s, – and which is still followed almost to the letter by the investment industry today who appear to stick together like a cartel and explain away their heavy losses with the same old drivel when doing very little to alleviate the losses by selling down to cash and safer assets in times when it is clearly the right thing to do, it does rather beg the question as to why contrarian points of view to the old stick in the mud, benchmark tracking, lazy buy and hold philosophies are scorned upon quite so much.  The answer is very obvious, – they hide behind benchmark performance as a relative indicator of their own, and remain with far too much volatility inherent within the underlying clients portfolios.

Please note that nothing written here by the author should be construed as giving advice, it merely outlines our thinking.  Any advice will be discussed and proposed on an individual basis with each client when any advice that is given should be fully discussed with us before proceeding with any proposals made.

If you enjoy reading this weekly update, please feel free to share it with your friends and / or family who may also find the contents of interest, and do not hesitate to contact us if you need any help, information or advice yourself about any of the areas covered this week. 

Yours sincerely,

Philip A. Simmonds MBA, LL.B(Hons), FPFS, Chartered MCSI

Chartered Wealth Manager | Chartered Financial Planner

Solicitor (company in-house solicitor)

Chief Investment Officer | Head of Strategy

E : phil.simmonds@private-office.co.uk

      phil.simmonds@private-office.law (for legal matters)