July Monthly Market Update
As at end of July 2022
When bad news becomes good news
Since the start of the year, investors have been beset by a perfect storm of slowing global economic activity, rampant inflation, and central banks increasingly becoming more hawkish in order to contain it. Add to this the systemic risks of the debt-laden property bubble potentially bursting in China, and Russia’s invasion of Ukraine destabilising the geopolitical order, it is not a surprise that global equities recorded six consecutive months of declines since hitting record highs in late 2021. Prolonged periods of down markets tend to beget sharp reversals known as ‘bear market rallies’. This was the case in July, where bad news essentially became good news, sparking a 7% rally in MSCI World (NZD) Index, which clawed back a significant portion of this year’s losses.
The bad news in this instance is the growing body of evidence from economic data and leading indicators that the global economy is showing increasing signs of deterioration. In the US, inflation ratcheted up again, with headline CPI increasing 9.1% year-on-year. GDP for the June quarter was -0.9%, its second quarter of contraction suggesting the US was in a technical recession, albeit not officially declared as weak labour market conditions were not met. Across the Atlantic, the European economy is showing severe signs of stress due to potential risks of gas shortages and rationing later in the year. The latest Ifo Institute Business Expectations survey reading sank to 80.3, which excluding the COVID period, is approaching historic GFC lows plumbed in December 2008.
Against this challenging backdrop and the narrative that a recession would likely alleviate inflationary pressures, markets began to pull forward expectations of Fed rate cuts to early next year. Reflecting this, long-term fixed interest rates fell sharply, benefiting global growth stocks with heavy year-to-date losses. Due to its large concentration of high-growth technology stocks, the US S&P 500 Index was the top performer with a return of 9.2%. European stocks followed closely, with the STOXX 600 Index returning 7.8%, helped by a currency tailwind as the EUR briefly fell to parity with USD for the first time since the early 2000s. Major Asian markets underperformed, with the Japanese Nikkei 225 Index seeing slightly softer performance of 5.3% for the month. The Chinese market suffered with the CSI 300 Index falling 6.3% and Hong Kong’s Hang Seng Index dropping 7.3%. Large technology companies such as Alibaba and Tencent were dragged sharply lower by renewed regulatory crack downs, and real estate developers sank due to a mass mortgage boycott on developments where construction has halted - further exacerbating problems for the fragile property sector.
NEW ZEALAND EQUITIES
Rising tide lifts all wakas
The New Zealand sharemarket was mostly swept along with the global equity rally in July, as the benchmark S&P/NZX50 Index performed roughly in line with peers returning 5.7%. Despite the solid bounce, the Index remains well below 2021 highs with a -11.8% return year-to-date.
Falling long term yields came as welcome news for some beleaguered growth and tech names, as seen with the top performers in the Index, transport technology company Eroad (ERD) and biotech Pacific Edge (PEB), returning 51.4% and 14.7% respectively. PEB rose sharply after a strong 1st quarter update, before giving up all the gains and more, shortly after month end on the news that its bladder-cancer test could be excluded from Medicare reimbursement by Novitas, a large US health insurance administrator.
Only 8 of the top 50 companies ended in the red for the month, with the worst performer being Restaurant Brands (RBD) which retuned -11.1%.
The company put out a profit warning late in the month, highlighting that margins continue to be squeezed as price increases were not enough to offset cost inflation. Other poor performers were Sky City (SKC: -4.8%) which fell on news the South Australian gaming regulator will undertake an independent review of the company’s casino in Adelaide; and SkyTV (SKT: -2.1%) where technology upgrades have been hampered by the global microchip shortage. Other headlines of note came from Port of Tauranga (POT) and Spark (SPK). POT returned 12.2% despite news that a decision on its port operator consent being extended will be delayed again until 2023. SPK returned 6.3% after announcing its intention to sell-down 70% of its mobile tower company, shortly followed by Infratil-backed Vodafone’s deal to realise an attractive $1.7b valuation for its towers.
Thinking about blinking
A perceived dovish pivot by the US Fed induced a broadbased relief rally which saw the S&P/ASX200 Index return 5.7%. Hopes of a faster return to looser monetary policy floated almost all boats, especially IT (+15.2%) and Property (+11.9%), given valuations in these sectors are particularly sensitive to interest rates. Materials (-0.7%) and Energy (+2.1%) were the laggards, owing to the recession fears underlying the pivot that was read into monetary policy.
The surge of risk-on sentiment magnified the effect of positive news flow, and this was felt most among ‘beaten-up’ tech stocks. Two prominent examples were Zip and Megaport, which were the month’s best performers, returning 158% and 77.8% respectively on the back of positive quarterly updates. Oncology biotech Telix was another standout, returning 63.1% on releasing first commercial sales numbers for its prostrate imaging product. Worst performers were coal miner Coronado (-14.8%) and prepaid card provider EML Payments (-14.6%). Coronado took another leg down as the market digested the impact of falling metallurgical coal prices, inflation pressures on costs, and a drop in production due to wet weather. Much troubled EML announced the shock departure of its CEO and an ambiguous update on remediation at the behest of Ireland’s central bank which was subsequently queried by the ASX.
In contrast to unseasonably heavy rain and flooding on the East coast, macroeconomic data have been a scorcher. Annualised CPI inflation accelerated from 5.1% to 6.1%, unemployment fell to a 48-year low of 3.5%, and the May trade surplus came in over A$5b ahead of expectations. With the RBA still behind the curve at 1.35% after its second 0.50% hike in early July, more large hikes to rein in the economy are likely in coming months. Market-implied pricing currently anticipates a 3% cash rate by year end.
Inflation still at sixes and sevens
Bond yields continued to decline in July, and are now down significantly from the peaks reached in mid-June. This amounted to strong returns for global bond markets, and also flowed through to other asset classes, providing some relief to investors across the risk spectrum. In the Antipodes, the S&P/NZX Investment Grade Corporate Bond Index returned 2%, versus 2.8% for the S&P/ASX Australian Corporate Bond Index, with both lagging their government bond counterparts. Long duration assets were key beneficiaries of the move lower in yields, and inflation linked bonds were a standout performer in both Australia and New Zealand, closing up 5.1% and 5.6% respectively for the month.
Inflation remains elevated across the globe even though central banks have picked up the pace on rate hikes over the past three months. On the international front, US headline CPI surprised to the upside with a 9.1% y/y print and core PCE inflation remains around 2.5 times the target inflation rate. Q2 inflation data was no exception for Australia and New Zealand, where headline inflation printed multi-decade highs of 6.1% and 7.3% y/y respectively. Strength in domestic demand was evidenced by high non-tradable inflation for New Zealand at 6.3% y/y which was above the RBNZ’s forecast.
In the face of a second consecutive 0.75% hike (to 2.5%) by the Fed, longer-term inflation breakevens continued to reflect the belief that softening demand will see inflation fade towards the target range. Associated commentary from Chair Powell did little to dampen market optimism on rate cuts occurring from mid-2023. An initial US GDP reading of -0.9% for Q2 also supported the case for lower rates. July monetary policy meetings for both the RBA and RBNZ saw moves in-line with consensus, each hiking by a further 50bp. The latter’s review statement highlighted the RBNZ’s commitment to the OCR track set in May as a necessity to curb inflation.