June was a brutal month for markets. Thankfully, July came to the rescue. The S&P500 bounced 9.1% (the third-strongest July on record). Equity indices across the rest of the world were no slouches (Chart 2). Bonds were bought, too; US 10Y yields fell 31.0bps, while they fell even more in Germany and the UK. Meanwhile, commodities recovered 4.0%, and crypto snapped out of its losing streak, at least for now.
What caused this? Through June, DM central banks turned up the heat – hiking interest rates aggressively – and markets thought we were heading for a recession. This harmed assets. However, in July, markets decided enough was enough. They thought the Fed had done the lion’s share of the work on inflation; they were calling for a peak in the price rises and cuts to interest rates in 2023. We disagree, but risk assets recovered, nonetheless. Central bank pricing was not the only driver, though: pessimism surrounding China appeared to have bottomed; Russian gas turned back on; and earnings could have gone far worse.
When positioning for what is to come, patience is key. That is because much is still to be decided: markets must awaken to the hawkish sound of the Federal Reserve drum (i.e., they need to price in many more hikes); the 2Q earnings season needs to finish; and the war between Russia and Ukraine needs a clearer path to resolution. In such an environment, preservation of capital is essential so overweighting cash is a prudent strategy. We stick to that view.
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Elsewhere, we remain underweight government bonds, favouring short tenors (say up to five years). This should be no surprise; we have been convinced the market is under-pricing Fed hikes since February. Should they hike the Federal Funds rate to 8%, as Dominique envisions, a recession would almost certainly ensue in 2023, and equities would face further declines. Therefore, we also remain underweight equities.
As the energy crisis plays out and supply-chain problems persist, we remain neutral commodities – they are still volatile, and it is better to not choose a directional bias, though John does see some upside for agriculture. We are also neutral crypto – specifically, neutral-bearish bitcoin and bullish ethereum.
Finally, in terms of equity sectors, here are our favourite views:
- Within the US, we like to be overweight financials, homebuilders, large-cap value, reopening trades, semi-conductors, traditional infrastructure, and underweight large-cap growth, consumer discretionary, materials and technology.
- Within Europe, we like to be overweight renewables.
Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.