Market Analysis July 2019

July witnessed modest gains in US equities, with markets outperforming their global counterparts. Trade tensions and their implications for investors and corporations led to increased demand for perceived safe havens, such as US Treasuries. However, robust Q2 earnings supported the relative strength of US markets. Towards the end of the month, the Federal Reserve executed a 25-basis point interest rate cut, although its announcement that this was not indicative of an ongoing series of rate reductions dampened investor enthusiasm, leading to a stronger US dollar.

The US economy's growth rate showed signs of deceleration, with Q2 real GDP expanding at an annualized 2.1%, a significant slowdown from Q1's 3.1%. The July flash composite purchasing managers' index (PMI) nudged up to 51.6, with the service sector counteracting the weakest manufacturing reading since 2009. Nonfarm payrolls for July added 164,000 jobs, aligning with estimates and maintaining the extremely low unemployment rate.

Communication services and information technology sectors performed notably well, driven by Texas Instruments and Alphabet's earnings exceeding expectations. Conversely, the energy and healthcare sectors faced weakness. As a reminder, past performance is not a reliable predictor of future results, and the mentioned sectors, securities, regions, and countries are for illustrative purposes only, not trading recommendations.

The MSCI EMU index saw a 0.1% return in July, reflecting the Eurozone's nearly unchanged equity performance. Strong Q2 results from Nokia and Danone boosted information technology and consumer staples sectors, while energy and financials experienced declines. Deutsche Bank's restructuring plan involved an 18,000 job cut and its largest quarterly loss since 2015.

The Eurozone's Q2 growth rate slowed significantly to 0.2% from Q1's 0.4%. In July, annual inflation dropped to 1.1% from June's 1.3%, prompting the European Central Bank (ECB) to announce plans for stimulus measures in September, potentially involving rate cuts. Mario Draghi's term as ECB president will be succeeded by Christine Lagarde.

The European Commission's decision not to discipline Italy over its budget deficit concluded that the government no longer breached the EU's fiscal rules. Spain's potential general election emerged as the Socialist party failed to forge a coalition with Podemos.

In July, the UK's stock market saw positive local currency performance, mainly attributed to a sharp decline in sterling's value due to increased Brexit uncertainty. This benefited firms with international earnings and spurred merger and acquisition activity. While several large-cap companies with stable growth prospects extended gains, concerns over the global economy remained. However, the share prices of these "quality growth" stocks outpaced their earnings growth.

Boris Johnson's appointment as prime minister with a "do or die" approach for an October 31 Brexit heightened concerns over a disorderly EU exit, contributing to a decline in the pound's value. Meanwhile, the Office for National Statistics reported a 0.3% GDP rebound in May after a 0.4% contraction in April.

The UK's manufacturing purchasing managers' index (PMI) dipped from 49.4 in May to 48.0 in June, and the services PMI approached the 50 contraction/expansion threshold at 50.2. These trends raised concerns about potential momentum loss in the consumer-exposed sector, dominant in the UK economy. However, June saw a rebound in retail sales, defying expectations for another monthly decline.

July yielded a total return of 0.9% for the Japanese stock market, accompanied by marginal weakening of the yen against the US dollar. Yet, the dollar's decline was reversed with the US's August interest rate cut. The Upper House elections in Japan resulted in the Liberal Democratic Party's victory, albeit falling short of the two-thirds majority necessary for constitutional reform. This confirmed policy continuity and effectively removed uncertainty regarding the consumption tax hike planned for October. The Bank of Japan maintained its policy stance while suggesting a more proactive approach if the yen's appreciation jeopardizes the real economy.

Japanese corporate earnings for Q2 faced the impact of trade disruption and global economic deceleration, yielding slightly negative earnings. Despite the market's anticipation of these factors, companies are likely to adopt a cautious approach to full-year guidance. The MSCI Asia ex Japan index returned negatively in July, with mixed Q2 earnings and regional economic data. South Korea and India experienced weakness due to trade disputes with Japan, disappointing Union Budget announcements, and subdued economic indicators. Taiwan's IT stocks thrived due to US-China trade developments, and Indonesia and the Philippines outperformed. China marked a slight negative return, although it outperformed the MSCI Asia ex Japan index. While trade talks with the US made limited progress, June saw China's economic data showing signs of recovery.

As the July 31 Federal Reserve policy meeting approached, expectations for a US interest rate cut surged. While a 25-basis point cut was certain, some anticipated a 50-basis point reduction. Ultimately, the Fed cut rates by 25 basis points to 2.00-2.25%. However, expectations for future rate cuts were tempered.

US 10-year Treasury yields remained unchanged by month-end, following a substantial year-to-date decline. Retail sales, labor market, and core consumer inflation data indicated strength, although manufacturing indicators were relatively weak.

European yields experienced declines, with the German 10-year yield falling seven basis points to -0.40%, and the French 10-year yield decreasing by 17 basis points to -0.18%. The Italian 10-year yield dropped over 50 basis points. While the ECB maintained its monetary policy settings, it hinted at potential September accommodation measures. Despite positive industrial production data, overall data remained restrained.

Boris Johnson's confirmation as the UK's prime minister increased the risk of a more extreme Brexit. Consequently, the UK 10-year gilt yield fell by 20 basis points. The Bank of England continues to perceive Brexit as a binary risk to its economic outlook.

Both investment grade (IG) and high yield (HY) corporate bonds fared well, surpassing government bonds. The gap between corporate and government yields narrowed. In the IG segment, euro and sterling markets demonstrated exceptional performance due to rate declines.

Emerging market (EM) bonds enjoyed a positive month despite the US dollar's rebound following a June drop. Some EM currencies performed well in anticipation of lower US rates.