August – How long can the party last
Despite all odds, August came out to be a strong month, though marked by stark contrasts between sectors. Leading the pack was energy (+7.2%), pushed up by the Middle East conflict with seemingly no end in sight. Following closely was the return to favor of technology (+6.2%). At the bottom of the pack were utilities (-4.8%) and industrials (-2.6%). Robust second quarter corporate earnings are to be thanked for the good performance. There are, however, two sides to the coin. With high energy prices comes higher inflation, leading to central banks having a more hawkish stance. Down the road, higher interest rates are typically perceived as bad news for equities, even more so for growth stocks. To exacerbate the interest rate problem, long term rates (10+ years) are rising to levels not seen in a long time, but more on that in the chart of the month section.
Inflation is still the data point everyone is looking at. The consumer price index is being dissected by its different components and by goods vs services, almost to fit a narrative. It is reassuring that, indeed, the rise in inflation stems mostly from energy prices. The July reading for the US came out at +3.4%. As a reminder, the Federal Reserve’s target and mandate is at +2%. Given the stickiness of inflation, the consensus is for a rise in interest rates in September and potentially another one in December, despite new Fed chair Warsh being perceived as more dovish. He may just not have sufficient votes to keep inflation at current levels.
Despite all the macroeconomic and geopolitical uncertainties, markets focused on the excellent second quarter results, over 80% of companies having beaten profit expectations, resulting in the strongest quarter in recent years.
Europe delivered similar exceptional corporate results in Q2, with over 70% of companies beating profit expectation, leading to the strongest quarter in over 3 years. But just like the US, inflation is also a thorn in the foot of the ECB. The August figure came out at 3.3%, up from 2.9% last month. The central bank is therefore likely to raise interest rates further in September.
In Asia, Japan continues to benefit from the AI hype, despite the joint intervention of the US and Japan to prop up the Yen in late July, which is typically something that Japanese stocks don’t like at all. Here as well, the effect of the intervention is slowly fading as markets have a different view and are always right.
House View
Given the good market performance, we have had multiple products autocalled and took advantage of short-lived volatility events to issue our usual structured products with downside protection.
Being long equities via passive ETF vehicles, we do not need to worry about the rotation happening in the different sectors, thereby avoiding churning the accounts to chase after trends.
Chart of the month
The chart of the month shows the 10-year yield on government bonds from USA (blue), France (white), Italy (green) and Japan (red) since the beginning of the year.
A few things are worth noting. Despite intervention from the US treasury on August 19 to reduce the long end of the yield curve, the impact was very minimal and short lived, almost nonexistent. There are two big reasons for this. For one, investors are starting to reconsider the risk-free nature of US treasuries given the constant budget deficit adding to US debt, now over the 40 trillion mark and a debt to GDP over 120%. Second, competition for capital from hyperscalers is making it more expensive for borrowers.
Another thing worth noting is that the French 10-year yield is higher than the Italian one. This is hard to believe, given that just 15 years ago, Italy was on the verge of collapse from its overwhelming debt, while France and Germany were imposing harsh austerity. Italy has since imposed fiscal discipline and political stability, whereas France is having issues balancing its budget and political will is not there.
Finally, Japan, which had their 10-year bond yield at close to 0% for decades, is now at about 3%. This rise is likely to make it very hard for the country to service its debt with a debt to GDP above 200%. Furthermore, this is having a big impact on global carry-trade, which is the way some investors borrow in currencies with cheap cost of borrowing like Japan to invest elsewhere.
Source: Bloomberg
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