July 2022 Market Update
The stock market tends to act as a leading indicator of the economy, such that stock prices reflect investor sentiment and expectations about future earnings and economic growth. During the first half of 2022, investor sentiment focused on the risk of a recession premised on higher inflation, rising interest rates, and a less-stable geopolitical environment. Beginning in July 2022, objective data began to align with negative investor sentiment and displayed the first signs of a slowing economy as evidenced by negative GDP data and lower earnings results.
With many major equity indices down roughly 20% for 2022, the data supporting the sentiment of a recession caused many investors to anticipate less aggressive central bank interest rate increases. This expectation counteracted prior negative investor sentiment priced into equities and resulted in positive returns for the month.
Image 1: The S&P 500 was up 9.11% in July, bringing its YTD return to -13.34%
Inflation continues to remain high with the United States reporting an annualized headline inflation rate of 9.1% for June, an increase from an annualized rate of 8.5% in May. In a continued effort to quell inflation, the U.S. Federal Reserve announced a 75 basis point (bps) interest rate hike in July, following a 50bps hike in May and a 75bps hike in June. Federal Reserve Chair Jerome Powell noted that the Federal funds rate is now close to their estimate of a neutral rate - the real interest rate that supports the economy at maximum output while keeping inflation constant. This comment suggests that over the next three meetings to close out the year, rate hikes could slow.
Alongside inflation data, the United States also reported an annualized second quarter GDP decline of -0.90%. This is the second consecutive GDP contraction, following an annualized -1.60% drop in the first quarter. Although a technical recession is defined as two consecutive quarters of negative GDP growth, analysts are hesitant to make this classification with the United States still experiencing a very strong labour market.
The annual inflation rate in Europe increased to a new record high of 8.6% in June, up from an annualized 8.1% in May. The European Union, which has lagged behind most G7 countries with respect to its monetary tightening, saw the Euro reach parity with the USD amid heightened recession risks and rising gas demand. In response, the European Central Bank delivered its first interest rate hike in over a decade, raising rates by 50bps in July. Despite this move, inflation is likely to remain elevated as Russia reduced gas supplies from the Nord Stream 1 pipeline to 20% capacity, citing the need to repair one of its turbines. It is likely this announcement has broader geopolitical motivations of preventing a build up of natural gas reserves prior to winter. The European Commission has requested that member countries look to reduce their gas consumption by 15% over the winter.
Sentiment for Chinese equities fell in June, largely due to the real estate sector as homebuyers further suspended their mortgage repayments on undelivered housing projects. In response, banking regulators have asked banks to extend grace periods for homebuyers and to offer credit enhancement tools to developers. China also continues to struggle with Covid-19 outbreaks and lockdown measures, with no sign that the country will move away from its zero-Covid policy. Despite its tight restrictions, China released second quarter GDP growth of 1%, most likely as a result of easing supply chain pressures.
