Edmond de Rothschild AM Market Flash: A transition period

During the week of 8 August, risk assets rose after July inflation in the US came in lower than expected and down on June. Investors were reassured and Fed rate hike expectations declined, especially for September, today more divided between 50 and 75 basis points of increase.

The week of 15 August was calmer. US economic data offered a more mixed picture. The Empire State index tumbled in August, dragged down by its new orders component. The NAHB index for August showed the property market was still deteriorating with a drop in housing starts and sales for July. On the other hand, industrial and manufacturing production rose 0.6% and 0.7% MoM. And in an indication of US consumer resilience, retail sales were upbeat for July. The Philly Fed index also rose significantly in August, a stark contrast with the Empire State. To boost the economy, Joe Biden signed the $430bn Inflation Reduction Bill into law. The plan targets healthcare, energy transition and climate change.

In Europe, inflation continued to worsen, hitting an annualised 10.1% in the UK in July, or above expectations, with underlying inflation running at more than 6%. In Germany, producer prices rose 5.3% in July. Gas prices returned to March highs due to stock rebuilding, reduced Russian exports and unfavourable weather.

In Asia, news on China's economy was downbeat. True, consumption and production rose in July but less than expected and at a reduced pace. The PBoC reacted with an unexpected rate cut. In Japan, however, second quarter GDP rebounded by a more encouraging 0.5% and domestic demand recovered.

Towards the end of the period, government bond yields started rising again and equity markets turned more volatile. Equity indices are now looking a little fragile after making strong gains over a month and ahead of the Fed possibly offering more clarity on its monetary policy at the upcoming Jackson Hole meeting.

Given the summer rally and persistent uncertainty on rate rises and economic growth, we are still slightly cautious on equities. We are close to neutral on duration but more wary of eurozone bonds.

EUROPEAN EQUITIES

Worries over inflation forced investors to factor in more restrictive central bank policy, sending bond yields higher. Inflation in the UK accelerated more than expected. The labour market showed some slight indications of slowing but wage tensions persisted.

Gas prices continued to rally. Availability will be a crucial challenge in Europe over the next few months. Some companies, especially in Germany, are already basing their objectives on a 25% reduction in available gas. Uniper, which is already the object of a rescue plan by Berlin, reported heavy losses due to soaring prices and reduced supplies from Russia.

In construction, Geberit missed its second-quarter EBITDA target due to operating cost inflation from rising energy, transport and overhead prices. Pricing power is paramount and the group is to raise prices again in October to offset reduced volumes. After warning in May and June on a significant fall in its new order book, Kingspan said the situation would remain poor. The increase in sales was mainly due to higher prices and acquisitions.

First-half net revenues at Adyen were up, but less than expected. The EBITDA margin fell due to a larger- than-expected increase in operating costs but the group stuck with its long-term targets thanks to the ongoing trend out of cash and into digital payments. Carlsberg maintained its 2022 objectives despite inflation. Rising costs may have curtailed the brewer’s results but investors chose to focus on rising volumes amid a strong post-Covid recovery and favourable consumer trends. Sanofi had to contend with another setback. The group abandoned development of its breast cancer drug Amcenestrant.

US EQUITIES

As the earnings season drew to a close, a positive picture started to take shape. With 90% of S&P500 results in, 52% have beaten expectations by more than one standard deviation, compared to 47% historically and 11% have fallen short (compared to 14%). However, this was not enough. Earnings beats outperformed the S&P by 49bp on the day the figures were released (compared to 102bp historically) and misses underperformed by 260bp (214bp).

Nevertheless, the rebound over the past month has been significant: +6.8% for the Dow Jones, +8.8% for the S&P500 and +10.7% for the Nasdaq.

A few macro indicators were released over the period, ahead of the Jackson Hole symposium on August 25- 27. Given the tight labour market and high inflation, consumption momentum is probably a key indicator for the Fed. So far, the Fed has been guiding markets towards further rate rises and brushing off any question of easing in 2023. But consumption has been trending lower in recent months (although there was a rebound in June) and recent results from companies like Walmart have been on the optimistic side.

On the other hand, last Monday’s data were hardly reassuring. The NAHB index of property developer confidence fell for the 8th month in a row, hitting a low not seen since 2014. The Empire State index tumbled more than 42 points in a month, pointing to a contraction in manufacturing in the New York region.

Analysts interpreted the latest FOMC minutes in a variety of ways, prompting comments from several Fed officials on Thursday that the bank was determined to raise rates to bring inflation under control. The pace of rate hikes is, however, still undecided. James Bullard (Saint-Louis Fed) wants another 75bp rise in September given the strength of the economy but Mary Daly in San Francisco thinks either a 50bp or a 75bp hike would be reasonable.

Elsewhere, in a rare show of Democrat Party consensus, the massive inflation reduction plan was approved. It is designed to boost investment in renewable energy and make access to some healthcare treatments easier. It also clearly favours US industry, a bias criticised by some other countries. China, for example, lambasted the $52bn earmarked for electronic chip subsidies. The vice-president of the Chinese semi-conductor industry association said the programme was overtly discriminatory.