July marked a strong rebound for global stock markets, with the MSCI All Country World Index recording its best monthly return since November 2020, gaining 7%. Despite aggressive interest rate hikes, government bond yields declined as economic data pointed to a potential slowdown.
Investors have been optimistic that the economic softening will expedite the end of the hiking cycle and potentially lead to interest rate cuts in the US next year. However, there is caution regarding this outlook, as the market may be overly optimistic.
In the US, equities outperformed in July, with broad-based indices rising over 9%, despite another 75 basis point increase in interest rates by the Federal Reserve. Growth stocks outperformed value stocks, and large-caps and small-caps performed similarly. While second-quarter earnings results have been solid overall, there are downward revisions in earnings estimates due to signs of economic activity slowing and the impact of recent interest rate hikes.
The US economy technically entered a recession, with a 0.9% contraction in Q2 GDP. However, other recessionary metrics, such as a fall in personal income or lower employment, have not been met. The 10-year Treasury yield declined to 2.65%, and the inversion of the yield curve between two-year and 10-year bonds suggests an expected economic slowdown.
Eurozone business activity unexpectedly contracted, and inflation remained high, with the consumer price index rising 8.6% year-on-year. However, the core inflation reading, excluding certain items, was lower at 3.7%. Despite economic concerns and ECB tightening, European shares experienced a strong bounce in July, outperforming other global benchmarks.
In the UK, there were political developments with Boris Johnson's resignation as prime minister and the race to replace him. UK shares lagged behind in July, but still rose around 3.7%. The UK experienced a new 40-year high in inflation, reaching 9.4% year-on-year. Employment figures, retail sales, and PMI data showed positive signs, while the Bank of England is expected to raise rates by at least 50 basis points in August.
Overall, equity markets benefited from short-covering and better-than-expected corporate results. However, caution is advised as the possibility of a consumer recession and the timing of a return to normalcy for inflation may require more time than anticipated.