The MSCI UK index delivered a return of 2.55% in July, outperforming the MSCI AC World (0.1%), MSCI North America (-0.14%), and MSCI Europe ex UK (-0.05%). While the major news in the UK last month was Labour's sweeping victory in the general election, which saw the party return to power after 14 years in opposition, the stronger performance of UK stocks is likely attributable to other factors. It appears to be a continuation of trends that started several months earlier, with relatively lower valuations, a catch-up trade, and sector rotation contributing to the gains of London-listed companies over their US and continental European counterparts.
US technology stocks have been the market's favorite since the rally began in October, but there are increasing signs that this momentum might be fading. After peaking in mid-July, US tech indices saw a notable correction of about 10%, including the largest single-day decline since 2022. While it is important to put this pullback in perspective—the index is still outperforming the broader market year-to-date—the size and speed of the drop suggest a potential shift in market leadership.
Investors are seemingly growing more cautious about profit expectations for companies involved in AI, with several second-quarter earnings reports from leading tech firms met with negative reactions. This is indicative of how high market expectations have become, as earnings and revenue have generally shown solid growth, but not to the extent anticipated by the market.
A significant portion of the strong performance over the past 10 months has been driven by the AI theme, leading to the "Magnificent 7" tech stocks (Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Nvidia, and Tesla) making up nearly one-third of US benchmarks. While this concentration is not inherently problematic, it does make the broader market more sensitive to the performance of a few companies, with any disappointments potentially having a wider impact on indices.
The ISM Purchasing Managers Index has shown mixed results, with the manufacturing component falling short of expectations for the fifth time in six months, while the services component came in above consensus forecasts.
Signs of a slowing economy have led to increased speculation about a possible US recession. However, the world's largest economy has consistently outperformed these predictions over the past 18-24 months. Despite a rapid tightening of monetary policy leading some to predict a recession last year, it did not materialize. Central bank policy has been in restrictive territory for the last 12-18 months, so a slowdown in activity is not entirely unexpected. Nonetheless, the past 12 months have been favorable for stock market investors, with US indices posting double-digit returns.
It's important to focus on the bigger picture: as long as layoffs remain relatively low, the US economy is unlikely to experience a severe downturn. We continue to anticipate a "soft landing," but are closely monitoring upcoming data for signs that could support or challenge this outlook. It's crucial not to overreact to short-term volatility and isolated data points, but rather to focus on the underlying strength and resilience of the current economic landscape.
Three central bank decisions within 24 hours at the start of the month drew significant attention. The Bank of Japan (BoJ) raised rates, the Federal Reserve (Fed) maintained its existing policy, and the Bank of England (BoE) implemented its first rate cut since 2020.
The BoJ unexpectedly increased its base rate to 0.25% from the 0%-0.1% range and reduced its bond-buying program. This policy tightening suggests that the BoJ believes inflation is returning in a sustainable manner. Unlike much of the developed world, which has struggled with high inflation in recent years and raised rates significantly to control it, Japan has welcomed the rise in global prices due to its long-standing battle with low inflation. The interest rate divergence has caused a significant depreciation in the Japanese Yen over recent years, but after hitting a 34-year low earlier in 2024, the Yen saw a marked appreciation in July, gaining nearly 7% against the US dollar.
Just over 12 hours after the BoJ's announcement, the Fed stated it would maintain its interest rate at 5.25%-5.50%, marking the eighth consecutive meeting to keep rates at a 23-year high. However, there were strong indications that a rate cut might occur at the September meeting, as the accompanying statement noted the committee was “attentive to the risks to both sides of its dual mandate,” suggesting a shift towards concerns about unemployment rather than solely focusing on controlling inflation. Stocks and bonds reacted positively to this news.
The next day, the BoE cut rates for the first time since the Covid-19 pandemic, reducing its base rate to 5%. The rate had been at 5.25% since August 2023, but the narrow vote (5-4) indicates it was a contentious decision. Given market expectations for a reduction, it could be considered a "hawkish cut." Moreover, the lack of strong consensus suggests this move does not necessarily mark the start of a sustained easing cycle. The bank's economic projections support this view, with inflation expected to rise to 2.7% this year before slowing.
Gilts ended July with positive returns, bolstered by growing expectations of the rate cut and a global shift to lower yields. A broad-based gilt index returned 1.99% for the month, recovering a significant portion of the declines seen in 2024. Overall, we believe the long-term outlook for bonds is positive, with inflation moderating and interest rates likely having peaked. However, we have some concerns for the coming months regarding the US election and the potential impact of a Trump presidency on longer-term bonds, especially given his preference for tax cuts despite the substantial US fiscal deficit. Tariffs and tighter immigration policies could also be inflationary if enacted. While this may have more significance for the US economy than the UK, global government bond markets are closely correlated.
Recent market movements have included substantial declines in sectors that had performed well earlier in the year. Many of these are cyclical and sensitive to economic growth, such as tech, Japan, and commodities. Corrections like these are not uncommon and are often seen as overreactions. The ISM non-manufacturing data exceeded expectations, and we believe that further indicators in the coming weeks will reassure markets that growth is not collapsing, but rather that we are gradually moving towards a soft landing. As always, we remain objective and prepared to adjust our viewpoint if the data trends strongly indicate otherwise, but for now, we maintain our current stance.
With more than two-thirds of the earnings season completed, companies across all regions have generally exceeded expectations. The tech and financial sectors are performing particularly well, despite some market weakness in tech due to high expectations. We are encouraged by the fact that companies continue to post profits above consensus forecasts, and that all major equity regions are expected to show year-on-year earnings growth in 2024 and beyond. Fixed income continues to offer attractive yields and is expected to mitigate declines for multi-asset portfolios if stock market volatility increases, as demonstrated by the recent bond rally during the market correction.