To The Moon

The narrative of elevated price pressures, hawkish central banks and recession fears have been well telegraph as of late. In this vein, sentiments of market participants have played snake and ladders over the past 6 months of the year as many hunt for a bottom in the prevailing market rout. So how did markets perform in the month of June?

Asset class performance

Global equity and bond markets appear to try to stage a comeback in May as we witnessed some gains in the equity and bond market place. However, bits of positivity from the month prior have once again faded. Global bonds gauged by the Bloomberg Barclays Global Aggregate Index registered negative returns of 2.66% while Global Equities, gauged by the MSCI World index shed 7.96% in USD terms.

Broadly, Global equities weaker performance did not come as a surprise to us. Buoyed by worries about sizzling hot inflation, aggressive rate hiking cycle plans by central banks to quell price pressures and China’s covid-zero policy possibly jeopardizing growth, sentiments of market participants are generally sour.

On the fixed income front, trading within the fixed income universe was tumultuous as investors weighed the implications of the ECB’s policy, persistent inflation and potentially more aggressive rate hike to combat inflation and at the same time search for safety as the equity market remains jittery.

Chart 1: US 10y yields marched higher again as the sell-off deepens. Source: Bloomberg

Geographical

Emerging markets (EMs) in the month of June outperformed western Developed markets (DMs) at a geographical level – the former registered negative returns of -3.68% while the latter declined 7.32% in SGD terms.The poorer returns that came from western developed markets was attributed to investors continual profit taking thanks in part to aggressive rate hike plans from central banks sparking recession fears.

Delving deeper, we note that European equities (gauged by the Stoxx 600 Index) underperformed those in the US (gauged by the S&P 500 Index). US equities which is more likely to suffer the brunt of the sell off this year was somewhat able to eke out a marginally better return despite possessing a greater weighting towards the technology sector – longer duration assets are naturally more sensitive to changes. In our view, the weaker performance of European equities is due to markets repricing for the European Central Bank’s (ECB) rate hike of 25bps which is due in July.

In Asia, China which has been shunned by investors for a year-long roared back to life, delivering a spectacular return of 11.51% in SGD terms as gleaned from chart 2. The rally which materialized against a backdrop where the economic outlook remains challenging is an encouraging sight. what drove the performance of Chinese equities stellar returns we opine, are 3 main factors: 1) marked improvements in economic fundamentals – the uptick in key economic data alongside easing of restrictive measures confirms that the worst is over for the omicron infested nation, 2) the divergence in policy stance in contrast to global peers – accommodative policy actions such as a reduction in Loan Prime Rate, tax rebates and infrastructure spending have been pledged by authorities and 3) further clarity on regulatory crackdowns which have spanned from last year.

Chart 2: Chinese equity market is the stand out performer this month. Source: Bloomberg

Sector

All sectors traded in negative territory in June, including the likes of the high-flying energy sector. In fact, out of the 11 sectors, the energy sector is one that experienced the largest decline, buoyed by a slew of positive (the OPEC+ declared production increases of 648k barrels/day in July and August) and negative (demand concerns stemming from China’s restrictive measures, a potential for another round of sanctions against Russian oil trades and considerations of a US energy exports limit) news headlines.

On the other hand, the technology sector suffers yet another month of beating as market participants turn a tad more cautious of a high likelihood of another 75bps hike by the Feds in July to quell inflation.

Chart 3: Oil Price volatility continues as investors assess the supply demand dynamics. Source: Bloomberg

Chart 4: A lacklustre month of trading for all sectors. Source: Bloomberg

Our thoughts ahead

Historically, a Fed hiking cycle has led to a recession occurring and one indicator that has been a relatively accurate indicator is the yield curve -in the past, an inverted yield curve where rates on short term government debt exceeds those on longer term debt has signaled that a recession may be round the corner. Nevertheless, we argue that a recession occurring in the US this year is unlikely due to strong economic fundamentals – sturdy labor market and strong balance sheets of corporates and households coupled with relatively resilient consumption will continue to drive growth this year.

That being said, with inflation running at the fastest pace in 40 years and growth poised to slowdown sometime next year, we see a possibility that stagflation could occur. Bolstering our opinion is the fact that higher rates will deter growth and higher commodity prices will likely continue to persist due to years of underinvestment that will take an unpredictable amount of time to resolve – in essence, growth will slow, and inflation should remain persistently high, bringing about stagflation. Therefore, we believe that more pain could lie ahead for global markets as the stagflation narrative has yet to be priced in fully in our opinion.

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