The digest
Global equities rallied again last week, with the MSCI World Index closing up 1%.1 Central bank announcements were the key focus for investors, as the Federal Reserve (Fed), the European Central Bank (ECB) and the Bank of Japan (BoJ) all released their latest updates. Dovish takeaways from the Fed and the ECB triggered the rally. We are also in the midst of second-quarter earnings season, which usually brings some extra volatility. Overall, the majority of companies which have reported have beaten earnings-per-share (EPS) estimates. In terms of fund flows, inflows resumed into US equity funds, which received US$9.9 billion last week, but it was another week of outflows for Europe-focused equity funds, which shed another US$1.3 billion, marking the 20th consecutive week of outflows.2
Central banks in focus
Fed
On Wednesday, the Fed raised interest rates 25 basis points (bps) as expected, taking the upper band of its key rate to 5.5%. In its statement, the Federal Open Market Committee (FOMC) slightly improved the commentary around economic growth, upgrading its description of economic growth to “moderate” from “modest”. In addition, Fed Chair Jerome Powell said the central bank’s economists are no longer forecasting a recession in 2023, given the resilience of the economy recently. However, he did note that they are still anticipating a noticeable slowdown in growth, starting later this year. Notably, it was mentioned that inflation does still remain “elevated” and the Committee doesn’t see inflation back at 2% until about 2025. On a more positive note, the statement said the banking sector remains “sound and resilient”.
The main takeaway seems to be that Powell is keeping his options open for the next meeting, which isn’t until 20 September (eight weeks away). Before then, we are due two Consumer Price Index (CPI) inflation reports and two monthly employment reports, so it is understandable that Powell was careful not to get tied to any actions for the next meeting. He said: “All of that information is going to inform our decision as we go into that meeting….It is certainly possible that we would raise [rates] again at the September meeting, if the data warranted. And I would also say it’s possible that we would choose to hold steady at that meeting”.
Importantly, a soft landing looks increasingly likely, and it seems like the market agrees.
ECB
Thursday’s ECB interest-rate decision was also a key market catalyst. The markets had fully priced in a hike of 25 bps ahead of the announcement; however, the focus for investors was more on the language of ECB President Christine Lagarde and any hints on expectations at September’s meeting. Prior to the meeting, the market had priced a 50/50 chance of a hike in September, too. The latest European Purchasing Managers Indices (PMIs) have disappointed across the board, signalling a worsening economic picture, so the market was on the lookout for any specks of dovishness. The July Eurozone Composite PMI came in at 48.9, vs. 49.9 previously. Within that, manufacturing was the clear disappointment, comfortably in contraction territory at 42.7 vs. 43.4 previous. Services were also lower at 51.1, vs. 52.0 previous.
As noted, the ECB raised rates 25 bps, increasing the deposit rate to 3.75%. There was very little guidance given on whether the central bank would hike again in September, instead highlighting that any decisions would be based on the data. Note, there are two more CPI readings before the next ECB meeting in September. So, like the Fed, the ECB will also have the benefit of a little more time in the sense of reviewing the full impact of the current tightening cycle. This is the first time this year that the ECB has not pre-confirmed a hike at the following meeting.
In terms of commentary, notably, the Council dropped the language around policy “having still more ground to cover”, which was taken as dovish. At the press conference, Lagarde struck a more balanced tone than previously. She said that the ECB has an open mind on decisions in September and beyond, playing down expectations for a hike. However, she did repeatedly insist that the ECB’s only goal was to achieve 2% inflation, “come what may”.
BoJ
On Friday, the focus shifted to the BoJ meeting. The focus for markets was on any tweaks to the central bank’s yield curve control (YCC) policy. Inflation remains above the BoJ’s 2% target, as the June core inflation rate accelerated to 3.3% from 3.2%.
In the announcement, the central bank introduced some flexibility to YCC. Specifically, it still targets the 10-year Japanese government bond yield at 0.0% but will allow variance of +/-0.5%, and that range will now be a reference point, not a rigid limit. This was taken as hawkish relative to the bank’s ultra-loose policies, and we saw the Nikkei Stock Index fall on the back of yen strengthening. Some observers noted that starting yield curve controls was akin to a rate hike, despite the fact that the BoJ also left its policy rate target unchanged at -0.1%.
In conclusion, it is clear to us that the Fed and the ECB are nearing the end of their hiking cycles. However, the market still appears to be split on a what September may bring, as data could push the decision either way. All eyes will be on the Bank of England (BoE) this week.
Week in review
Europe
The STOXX Europe 600 Index saw a third consecutive week of gains, up 1.1% last week, whilst the STOXX Europe 50 gained 1.7%. The rising belief that the ECB is nearing peak rates helped lift equities towards the end of the week. Also, China Politburo stimulus headlines helped broader sentiment. Aside from that, the market was swamped with corporate earnings, as a third of the STOXX 600 Index have reported. Of note, Europe’s largest company (by market cap), LVMH, reported weaker numbers, trading down 3.1% on the week.
Sector performance saw a tighter spread between the best-performers (autos and technology) and worst (utilities and oil and gas). Cyclicals slightly outperformed defensives. US interest rates moved higher, with the 10-year Treasury back at 4%.
Market breadth improving: It is interesting that market breadth has improved on the recent rally, after so much was made of the narrow market breadth in the first half of the year.
European macro data: There is a reoccurring theme of weak macro data out of Germany, as gross domestic product (GDP) stagnated in the second quarter. For the doves, French inflation dropped to the lowest level for 16 months, as falling energy prices brought consumer price growth down to 5% in June from 5.3% the previous month.
In addition, ECB business loan data, a key data point for the ECB, was weak.
United States
It was another positive week for US equity markets, with the dovish FOMC meeting leading the market higher. The S&P 500 Index closed the week up 1.0%, whilst the Russell 2000 Index was up 1.1% and the Nasdaq Index was up 2.1%. Of note, on Wednesday, the Dow Jones Industrial Average notched its 13th consecutive positive day, marking its longest winning streak since 1987.3 The index did sell off on Thursday but recovered lost ground again on Friday to close the week up 0.7%.
Away from central bank rhetoric, second-quarter earnings season continues to be a key focus for investors. According to a research note from JP Morgan, 80% of companies are beating EPS estimates in the United States, with a larger-than-usual magnitude of surprise.4 However, it seems that companies that are beating earnings expectations are not being rewarded as much as they typically have, while those that are missing are being penalized more harshly.
In terms of macroeconomic data, US flash PMIs on Monday were mixed. US flash manufacturing PMI beat expectations, but was still in contraction territory, whilst the flash services PMI missed, but was still in expansion. Thursday’s macro releases were strong, with second-quarter GDP beating estimates, whilst June Durable Goods Orders beat significantly, and weekly jobless claims came in below expectations. On Friday, June core Personal Consumption Expenditures (PCE) was in line with expectations, decelerating from May and now up 4.1% year-over-year. Personal spending increased faster than estimated.
Asia Pacific
It was a better week overall in Asia, with the MSCI Asia Index closing up 2.45% last week on the back mainly of the Chinese Politburo meeting and the BoJ release on Friday. News of China stimulus earlier in the week was a further tailwind for Chinese equities. The Politburo stated the economic recovery was “tortuous” and it was “necessary to actively expand domestic demand” and “expand consumption by increasing residents’ income”. There was not too much detail, but clearly supportive for sentiment. The BoJ is discussed in more detail above, but the long-talked-about softening attitude towards a hard YCC policy seems to be coming true (at last)—albeit change is incremental, rather than significant.
Japan
Last week was solid for Japanese equities, which closed higher as the BoJ surprised investors (as discussed above) by tweaking its monetary policy, announcing that it would increase flexibility around its YCC target. It also revised its forecast higher for consumer price inflation in 2023. Yields on government bonds rose and the Japanese yen strengthened. Overall, banks, insurance and rubber products were the best-performing sectors, while utilities, foods and steel were the worst.
China
Last week was strong for mainland Chinese equities. The benchmark index closed up 3.42%, mainly due to the positive pro-growth tone (albeit no hard detail) out of the Politburo meeting and hope for a range of supportive economic measures, setting a supportive tone for the second half of the year. The government also vowed to put in place several measures to support the ailing real estate sector—more relaxation on purchase and mortgage loans may come for tier-1 cities in addition to the recently announced urban village renewal projects. Cyclicals including property, building materials, and construction stocks all outperformed.
The meeting also put consumption ahead of industrial policies and reiterated the goal to expand consumption in automobiles, electronics, household items, tourism etc. Local government debt risks were also addressed, and the meeting said China will implement a series of new policies to resolve the risks. For capital markets, the meeting pledged to reinvigorate the market and lift investor confidence with more supportive measures like T+0 trading, stamp duty tax cuts, etc. The market gained ground despite some softer economic news, including weaker GDP and other growth numbers. Elsewhere, Pan Gongsheng was appointed as the governor of the People’s Bank of China PBoC), although this was expected.
Hong Kong
Stocks in Hong Kong performed well, closing up 4.4% last week, again on the back of the Politburo meeting and hope for a range of supportive measures across the spectrum. Chinese developers bounced after China’s government pledged to optimize and adjust property policies to ensure the sector’s healthy development, together with press speculation that the government will continue to ease property policies in the second half of the year. Auto and auto parts stocks jumped after authorities released the latest version of standards for connected cars, also helped by sentiment from Xpeng’s new long-term strategic agreement with VW. Tech giants advanced as the PBOC called on the financials sector to provide more support for tech companies, while the largest tech firms were asked to provide case studies of successful startup investments, in further signs of easing in the sector.
Week ahead highlights
Monday 31 July
- Italy GDP; Italy HICP Inflation
- UK Mortgage Approvals; UK Consumer Credit
- Euro-area GDP; Euro-area CPI estimate
- Netherlands CPI EU Harmonized and Retail sales
- Germany Retail Sales; Germany GDP
- Switzerland Retail Sales Real
- Spain Current Account Balance
- US Chicago PMI
Tuesday 1 August
- UK Nationwide House Prices
- Germany unemployment change
- Italy unemployment rate
- Eurozone unemployment rate
- US S&P/Markit Manufacturing PMI; US Manufacturing ISM & Construction spending & JOLTS job openings
Wednesday 2 August
- Spain unemployment change
- Switzerland PMI Manufacturing
- US ADP employment; US housing inventories
Thursday 3 August
- Germany Trade Balance; Germany HCOB Services PMI
- Switzerland CPI
- France Budget Balance YTD
- Italy HCOB Services PMI; Italy Retail Sales
- France HCOB Services PMI
- UK S&P Global/CIPS Services PMI; UK Decision-Maker Panel Survey; BoE meeting
- Eurozone PPI
- US Challenger layoffs; US Nonfarm business productivity and continuing jobless claims; US Factory Orders
Friday 4 August
- Germany Factory Orders
- France Industrial and Manufacturing Production
- Spain Industrial Output
- UK New Car Registrations; UK S&P Global/CIPS UK Construction PMI
- Italy Industrial Production
- Eurozone retail sales
- US July employment report (nonfarm payrolls, unemployment rate, average hourly earnings)
Views you can use
K2 Hedge Fund Strategy Outlook: Third quarter 2023
The current environment looks favorable for equity market neutral, global macro and insurance-linked securities, according to K2 Advisors. The team offers its mid-year outlook for these and other hedge fund strategies. Read more.
Japanese stocks—In the land of rising dynamism
Mutual Series’ Christian Correa and Mandana Hormozi believe the Japanese equity market is finally benefiting from reforms, inflation, and efforts to push companies to focus on growth and improve their valuations. Read more.
Quick Thoughts: Artificial intelligence—A primer
Looking at the potential benefits, risks and societal changes of artificial intelligence from an investment lens with Stephen Dover, Head of Franklin Templeton Institute. Read more.
Running of the bulls
Equity markets have rallied since October, but the Franklin Templeton Investment Solutions team thinks markets have run ahead of both current and expected growth. Learn why—and what it may mean for investors. Read more.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.
Equity securities are subject to price fluctuation and possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
Special risks are associated with investing in foreign securities, including risks associated with political and economic developments, trading practices, availability of information, limited markets and currency exchange rate fluctuations and policies; investments in emerging markets involve heightened risks related to the same factors. Sovereign debt securities are subject to various risks in addition to those relating to debt securities and foreign securities generally, including, but not limited to, the risk that a governmental entity may be unwilling or unable to pay interest and repay principal on its sovereign debt. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments.
China may be subject to considerable degrees of economic, political and social instability. Investments in securities of Chinese issuers involve risks that are specific to China, including certain legal, regulatory, political and economic risks.
Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.
Past performance is not an indicator or guarantee of future performance. There is no assurance that any estimate, forecast or projection will be realised.
Links to External Sites
Franklin Templeton is not responsible for the content of external websites.
The inclusion of a link to an external website should not be understood to be an endorsement of that website or the site’s owners (or their products/services).
Links can take you to third-party sites/media with information and services not reviewed or endorsed by us. We urge you to review the privacy, security, terms of use, and other policies of each site you visit as we have no control over, and assume no responsibility or liability for them.
IMPORTANT LEGAL INFORMATION
This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. This material may not be reproduced, distributed or published without prior written permission from Franklin Templeton.
The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realised. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance. All investments involve risks, including possible loss of principal.
Any research and analysis contained in this material has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. The mention of any individual securities should neither constitute nor be construed as a recommendation to purchase, hold or sell any securities, and the information provided regarding such individual securities (if any) is not a sufficient basis upon which to make an investment decision. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.
Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own financial professional or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.
_______
1. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
2. Source: Bloomberg, BofA’s Hartnett Says Real Rates Not High Enough to Pop AI Bubble.” 28 July 2023.
3. Source: CNBC. “The Dow missed its 14th straight gain — a coin flip could have done that.” 28 July 2023.
4. Sources: JP Morgan, Bloomberg Finance.