July was a bumper month for stock market returns, depending on where you were invested, as shown in the chart below. If you had exposure to US equities, and in particular technology stocks, then your portfolio received a nice performance boost.
So what happened? As we entered July investors’ fear over a possible recession in the US (and elsewhere) started to trump their concerns about high inflation. This was reflected in falling commodity prices, particularly copper and the fact that the bond market began to rally (meaning yields were falling). We even saw the US yield curve invert and further dollar strength, all acting as warning signals of an impending US recession.
But we also saw equity investors starting to believe that the US economy may ultimately withstand monetary policy tightening from the Federal Reserve as it tries to quell inflation. By contrast, they had less belief in the eurozone economy. This theme continued in July as US equities outperformed European equities.
At the start of July, despite growing concerns about the possibility of numerous economies entering a recession, investors weren’t selling out and sitting in cash, instead rotating into alternative areas of the market. It suggested that the greatest fear for investors was actually the fear of missing out (FOMO) when central banks are forced to stop hiking rates and begin loosening monetary policy again. That trend accelerated as the month progressed buoyed by optimistic outlooks from US banks’ earning reports and signs that US tech earnings were weathering the economic slowdown better than expected.
In particular, Apple’s sales and profits beat analysts’ expectations and it was also positive about the prospect for future revenue growth, which sent its share price higher. As goes Apple, so goes the market.
But it was the market’s reaction to the US Federal Reserve's (the Fed's) latest monetary policy decision and associated press conference which really fuelled investors’ FOMO during July. The acknowledgement from Fed Chair, Jerome Powell, that the Fed may be near its neutral interest rate and will now rely on economic data to decide whether to raise rates in the future caused the market narrative to shift significantly. Previously the belief was that the Fed would hike interest rates and ultimately crash the economy, with its sole focus on bringing down inflation. With the market desperate for signs of a Fed pivot (from hawkish to dovish) this was jumped upon by investors.
As future interest rate rise expectations tumbled this lit another rocket under US technology stocks in particular, a sector where value investors were finally beginning to circle. It meant that buying the dip returned to investment markets in July, something we didn’t see in the first half of 2022 when equity markets stumbled.
The updated technical analysis chart below for the S&P 500 shows the positive impact of July’s equity market rally. The question then becomes, is this sustainable, and will it translate to other equity markets around the world?
August Outlook
In these monthly notes I often refer to the 10-month moving average indicator, not because it is fool-proof in any way, but because it visually shows the level of damage that has yet to be undone, in circumstances such as we are now, for many investors to become interested.
As the chart below highlights, in order to trigger a buy signal then the S&P 500 needs to hit 4300 by the end of August. That would represent a 3.5% rally from where we are now, which based on July’s rebound is certainly possible.
Those investors feeling FOMO are already piling back into the market, and may be proved right. The largest bear market rally in history was 23%, set during the financial crisis. If we get a similar rally, assuming it started from the year-to-date low in June, then the S&P 500 would need to hit 4500.
But as I highlighted last week, after the 23% rally in 2008/9 the S&P 500 fell more than 27% before hitting the ultimate bottom achieved during the financial crisis bear market. Interestingly if you look at the earlier technical analysis chart for the S&P 500 you can see that both the 4300 and 4500 are key technical lines of resistance. If we break and hold above both of those levels then there is a much greater chance that we could revisit all-time highs again. You will also notice the S&P 500 is sitting right on a line of support at 4150 - so what happens next will be telling.
However, much of the current rally is built upon a narrative that the Fed in particular won't keep raising interest rates and that inflation has peaked. If these assumptions prove false and the fundamentals (especially economic data which has even more importance now) disappoints then things could still unravel pretty quickly.
At the moment the storming rally in US equities is not translating to the same degree in the UK, for example, but if the FTSE 100 could get back above 7500 then things will become interesting.
On a positive note, the Bank of England, the Fed and the European Central Bank now don’t meet until September. In the case of the Fed it isn’t until 20th-21st of September. On the one hand it could be good news for market volatility, but we are still likely to hear from central bankers towards the end of August when they meet at the annual Jackson Hole Symposium.
Ultimately recession is still likely to remain the market obsession in August, unless geopolitical tensions relating to Ukraine/Russia and China/Taiwan ratchet up. The US has technically already entered a recession, according to the latest GDP data just out, but this has been all but officially dismissed for some reason. In the UK the Bank of England has now predicted that the UK will enter a recession later this year and will remain in one until 2024! Of course equity markets always tend to front-run the economy and rebound far sooner but the bond market is definitely not convinced that the economic outlook warrants such enthusiasm as we’ve seen in equity markets over the last month. The US yield curve is the most inverted since the year 2000 and equity markets tumbled back then. In August we will likely find out whether equity markets are being too optimistic or whether bond investors have become too bearish.
Chatterbox
As usual, there is a new Chatterbox this month where you can pose questions or discuss anything you want in its comments section. After 5 years I'm finally taking a holiday so will be travelling for much of August and will have limited access to Chatterbox. I will reply to any messages as soon as I am able.
80-20 Investor data
Now that I've updated the 80-20 Investor Best of the Best funds I will only be sending out stop loss alerts relating to these funds. If you have invested in any of July's selection that did not make it into August's Best of the Best funds you will need to monitor these yourself from now on. For those funds that remain in the 80-20 Investor Best of the Best fund selection all stop loss alerts were reset on the 1st August 2022. So the alerts will be triggered by a 5% price fall from the highest price attained by each fund during the calendar month of August.
Enjoy the newsletter
Damien Fahy
80-20 Investor & Money to the Masses founder
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