The digest
Global equities sold off last week, pulling back sharply at the start of the new month. The MSCI World closed the week down 2.3% after finishing July up 3.3%, while regionally, the S&P 500 Index closed down 2.3%, the STOXX 600 Europe Index was down 2.4%, and the MSCI Asia Pacific was down 2.1%.1 Ratings agency Fitch downgraded US credit from its AAA status to AA+, which weighed on equity markets. The Bank of England (BoE) raised rates by 25 basis points (bps), less than the 50 bps some feared, which tempered losses a bit.
As we head into August, risk assets face a series of headwinds. Firstly, seasonality is not in favour of risk assets in Europe—August-September represents the worst period of the year historically for returns in the region. In addition, if we look back at both March and the start of July, when the US 10-year Treasury note moved up to 4% or beyond, stocks have sold off, and we saw similar action play out last week. Finally, equity market performance has been strong of late, and many investors may feel it’s time to take some profits; globally, stocks haven’t had a >1% daily loss since May.
Fund flows were mixed last week, according to the latest Bank of America “Flow Show” report. US equity funds received another inflow (although small) of US$0.3 billion.2 Emerging market funds saw a fourth consecutive weekly inflow, US$4.1 billion in the latest period. However, European-focused equity funds saw their 21st consecutive week of outflows, shedding US$3.3 billion. European funds have now lost nearly US$38 billion overall year-to-date.3
European equities had rallied into month-end in July, and with some fanfare too, as the Euro Stoxx 50 Index traded firmly through 4400 for the first time since 2007. It became apparent that a so-called “de-grossing” amongst the hedge fund community was a primary market driver, with these participants largely covering short positions in the market.
Week in review
Europe
Last week, European equities pulled back quite sharply from recent highs, with the STOXX 600 Index closing the week down 2.4%. In terms of data, eurozone second-quarter gross domestic product (GDP) was up 0.3%, higher than expected. The eurozone July preliminary Consumer Price Index (CPI) reading was up 5.3%, in line with expectations, while the eurozone June Producer Price Index (PPI) deflated more than expected, down 3.4% on the year. This suggests that producers are passing on the effects of declining prices to customers. The decline in retail sales slowed in June, down 1.4% year-on-year vs. the drop of 2.4% in May.
Corporate earnings also market drove moves last week, as 80 of the STOXX 600 Index companies reported. Almost all European sectors finished in the red last week, with oil and gas the only sector to finish higher overall.
As noted, the BoE lifted interest rates 25 bps to 5.25% as expected. The Monetary Policy Committee (MPC) vote was split 6 to 3, with two voting for 50 bps and one on hold. The MPC also kept its forward guidance, stating: “If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.”
BoE terminal rate expectations have fallen again, with the market now anticipating a peak of 5.71% for March 2024.4That compares with the expectation of a peak of 6.50% from back at the start of July.
Sentiment on European equites remains fairly cautious. The Financial Times ran an article last week suggesting European assets had fallen out of favour with investors titled: Investors turn gloomy over Europe’s economic outlook.”
Looking at upcoming European macro events, the eurozone CPI will be released 18 August and GDP on 16 August. There is no European Central Bank (ECB) meeting in August—the next ECB meeting is on 14 September.
United States
US equities sold off last week, paring nearly all of July’s gains. The S&P 500 Index closed last week down 2.3% after finishing July up 3.1%. Corporate earnings were in focus again and over 80% of the companies in the S&P 500 Index have now reported, with the majority beating expectations. The Fitch US debt downgrade from AAA to AA+ garnered the most attention last week, spooking investors a bit and causing the S&P 500 Index to close down 1.4% on Wednesday.
Fitch had warned that it was considering a downgrade back in May as it highlighted the ballooning fiscal deficit, which has increased by US$1.39 trillion year-to-date, up 170% vs. the same period in 2022.5 Based on projections from the Congressional Budget Office, US public debt is expected to rise $5.2 billion every day for the next 10 years, and sovereign debt of US$52 trillion by 2033.6
Last week, the US July employment report also caught market attention. Non-farm payrolls increased by 187,000 in July, which was slightly lower than anticipated, but the unemployment rate ticked down to 3.5% vs. 3.6% in June, representing one of the lowest rates of unemployment in decades. On balance, the positive news in the unemployment rate and only a small increase in hourly wages seemed to offset the slowing in headline payroll gains and the downward revision to prior months. Note, we are due another employment report before the next Federal Reserve meeting and interest-rate decision in September.
Looking at market sectors, similar to Europe, all sectors apart from energy closed last week in the red. The VIX Index was up sharply off the lows last week, rising 28%.7
Asia
Last week was poor for equities in Asia, with the MSCI Asia Pacific Index down 2.11%, mainly on the back of last week’s US credit ratings downgrade, the Bank of Japan’s (BoJ’s) recent relaxation of its yield curve control (YCC) and the market’s disappointment in the lack of tangible government support for the Chinese economy.
Japan
The Nikkei Stock Average closed last week down 1.73% despite some decent earnings releases during the week.
The BoJ’s announced tweaks to YCC policy remained in focus. As a reminder, on 28 July the BoJ announced it would “conduct yield curve control with greater flexibility” with the ranges “as references, not as rigid limits” and said it would offer to purchase Japanese government bonds (JGBs) at 1.0% every business day. The BOJ kept its actual YCC parameters unchanged, holding the target band for the 10-year JGB yield at around 0% +/- 0.5 percentage points. But in practice, the band’s ceiling has now been raised to 1.0%, with the BoJ offering to buy debt at that rate every day. As a result, last week the yield on the 10-year JGB rose to 0.655%, near a nine-year high. The Japanese yen also weakened versus the US dollar.
China
Last week saw equities in mainland China close fairly flat (just into the green), as speculation of more government support for the economy outweighed some bearish economic data.
Numerous state bodies have released statements indicating help and support for the economy with measures that include:
- boosting demand in electric vehicles and housing;
- cutting taxes for small and medium enterprises;
- attracting foreign investment;
- helping employment of the young; and
- easing local government debt risk.
However, there has been little hard evidence of actual support (so far), which seems to be holding markets back.
There was some softer economic news last week, with the Official and Caixin Manufacturing Purchasing Managers Index (PMI) readings coming in at 49.3 and 49.2 respectively, both dropping below the important 50 level, which separates growth from contraction.
Sector-wise, brokers and stock trading software companies rallied last week as local investors were enthusiastic about the possibility that China may allow day-trading for some A-share stocks.
Forecasters are anticipating July’s export data will show a double-digit decline and could sound another alarm to China’s struggling economy.
Hong Kong
The Hang Seng Index closed down 1.89% last week as many investors found the Chinese government’s measures to stimulate the economy a bit disappointing. Despite the announcements stating the intention to stimulate (as noted above), the market perception has been that there have been few details and even less cash to translate the plans into an economic impact.
The People’s Bank of China said that it would step up its counter-cyclical measures to support the economy and create new tools if necessary, pledging especially to support property companies. However, it is not clear how far that support will extend in financial terms. Despite the pledges of support, Chinese property companies closed lower last week.
Inflation figures coming out this week are expected to show the Chinese economy fell further into disinflation. In addition, observers anticipate a sharp drop in aggregate financing and new loans.
Chinese five-year and 10-year bond yields now are near their lowest levels since March 2020.
Week ahead
Holidays: Friday 11 August: Japan
Monday 7 August
- Switzerland unemployment rate
- Germany Industrial Production
- Sweden Budget Balance
- Norway Industrial Production
- Euro Zone Sentix Investor Confidence
- US Consumer Credit
- China Trade Balance
Tuesday 8 August
- Netherlands CPI
- Germany CPI
- France Trade and CA Balance
- US NFIB Small Business Optimism; US international trade balance
- China CPI; PPI
Wednesday 9 August
- Norway average monthly earnings
- UK RICS House Price Balance
Thursday 10 August
- Netherlands Industrial sales and Manufacturing Production
- Sweden Industrial Orders
- Norway CPI
- Italy CPI EU Harmonized
- US CPI and Jobless claims; US Federal budget
Friday 11 August
- France ILO Unemployment Rate
- UK GDP and Manufacturing and Industrial Production
- France CPI
- Spain CPI
- Italy Trade Balance Total
- US Core PPI
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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. Bloomberg, “BofA Clients Turn Cautious, Flee From Stocks on Recession Risks.” 4 August 2023.
3. Ibid.
4. Source: Bloomberg World Interest Rate Probabilities (WIRP), as of 7 August 2023. There is no assurance that any estimate, forecast or projection will be realised. To perform the calculations for this model, WIRP collects price data for a list of assets from the futures market and uses this data to derive interest rate projections for each upcoming central bank meeting.
5. Source: US Treasury fiscal data, Treasury.gov. As of 7 August 2023.
6. Sources: BofA Global Investment Strategy, US Congressional Budget Office. There is no assurance that any estimate, forecast or projection will be realized.
7. The CBOE Market Volatility Index (VIX) measures market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Often called the “fear gauge”, lower readings suggest a perceived low-risk environment, while higher readings suggest a period of higher volatility.