Equities responding to a higher rate environment
Eley Griffiths Group
Global equity markets (ex-China) rebounded strongly in July. The Small Ordinaries Accumulation Index rallied +11.4% over the month, a significant outperformance against large caps which gained +5.5%.
There was early indication that bad news is now being discounted into stock prices. Markets pushed higher despite the US CPI report for June the highest print in 41 years, 9.1% year on year compared to the 8.8% estimate. Equities took the number in its stride failing to extinguish the "risk on" sentiment. As predicted, The Federal Reserve (Fed) raised rates by 75bp in response and whilst Fed Chair Powell's broader messaging didn't overly change, comments that the US economy may be showing signs of slowing were less hawkish than expected. The war on inflation is being won. The market responded by pricing in a lower peak Federal Funds rate and increasing the likelihood that rates may be eased in 2023 reflecting the impact higher rates will have the on real economy.
Locally, the Reserve Bank of Australia delivered +50bps after the Q2 CPI came in at 6.1% YoY, the highest since 1990. Once more, equity markets responded positively to the dovish post-meeting statements, "we don't need to return inflation to target immediately… we are seeking to do this in a way in which the economy continues to grow, and unemployment remains low" (Australian Strategic Business Forum, 20 July 2022 Governor Lowe).
Outside non-gold resource names and agricultural stocks, the upswing was sectorally broad based. Standing out were those most beaten-up by inflation and central bank rate hike fears, namely Information Technology (+18%) and Financials (+15%).
Focus now turns to the August corporate earnings results and whether investors have been heavy handed in their treatment of stocks. The lead from the US 2Q reporting season has been adequate. Attention will be trained on the impacts of inflation on operating cost structures, a higher rate environment and the health of the consumer.
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