With the arrival of August, it is time to take an in-depth look at the markets: what was the summer like and what themes should investors keep track of in the commencing Q3?
During the summer, the focus of fixed income market investors was on rising interest rates and changing interest rate expectations, while investors in the equity market have shifted their attention away from a market dominated by tech giants and onto new winners.
In the United States, interest rates are currently closing in on their 2022 peaks, while in Germany they have exceeded them. Interest rates have increased steadily since the start of the war in Iran because the conflict has raised both inflation expectations and actual inflation, especially due to escalating fuel and fertiliser prices.
Over the summer, the rotation has returned to the equity markets with investors beginning to transfer assets out of the largest technology and semiconductor companies to other sectors. This was especially obvious on the emerging markets where the spring’s strong tech stock fell behind the rest of the market after the summer.
In honour of the new quarter, it is, however, also time to look forward: what key market themes should investors keep track of in Q3?
Despite the somewhat negative economic growth headlines, both economic growth and companies’ earnings growth still appear relatively strong, and the themes behind the negative headlines have not significantly weakened economic growth. Industrials have continued to rally, and the energy supply challenges resulting from the war in Iran, for example, have yet to slow down industrial activity. This is a good thing for strongly industry-dependent Europe especially.
Another even more central theme can be found across the pond in the USA. In recent years, the entire global economy has more or less relied on US households. What is key in terms of economic growth is that US households have continued to spend, and domestic consumption has remained strong there.
Earlier signs of a slowing labour market have ceased in the United States. Consumers continue to spur on the economy and the Q2 earnings season also appears to be relatively strong against expectations.
In addition to the USA, the euro zone has also seen cautious signs of recovery. Economic data released in recent weeks has been stronger than expected and, for example, many leading indicators have taken a turn for the better although growth is still slower than in the USA.
The markets currently have two key concerns which have not dissipated during the summer. Especially the growth rate of AI and technology investments has slowed, and although investments are still being made, the fastest period of acceleration seems to be over. This has raised questions on the markets about what will happen next, which has increased the volatility of tech companies, especially in July.
From an economic standpoint, one of the biggest questions has to do with economic growth in the United States, where, aside from private consumption, a major driver of growth has been the building of infrastructure related to AI and the construction of new data centres. If these investments were to slow down, they would consume a large chunk of economic growth and stoke equity market volatility.
The war in Iran already drifted out of the markets’ focus earlier, but came back into focus when the strikes in the Middle East accelerated again at the end of July. The prolonging of the war increases the threat of accelerating inflation, which would raise interest rates and weaken consumers’ position.
Interest rates have risen in July in both the USA and Europe. In the USA, the interest on the 30-year government bond is nearing its highest ever figures in 20 years, and in Europe too, interest rates have risen largely due to the inflation expectation. Higher interest rates often have a slowing effect on growth, and the still elevated inflation is creating challenges for the central banks.
At the moment, the US Fed is facing some big questions: what to do when economic growth is robust and the labour market is strong, but inflation is accelerating? The markets’ interpretation of the situation has largely been that interest rates should be hiked. Market expectations concerning the Fed’s September interest rate hike have risen, in fact. Meanwhile, the European Central Bank (ECB) already raised its key interest rate at its meeting in June.
Also the Fed’s new tighter communication policy is stirring up the markets. New winds are blowing at the central bank owing to the new Fed Chair Kevin Warsh. Over the past twenty years, the markets have become accustomed to the Fed anticipating its actions and striving to communicate them to the markets well in advance. However, Warsh’s take on this is that the Fed should not try to predict the economic and inflation outlook and steer the market, but instead react to market developments. The Fed is expected to adhere to significantly more opaque communications going forward.
Autumn on the investment market is taking off in a situation in which economic and earnings growth continue to support the markets, but simultaneously, the rise in interest rates, geopolitical risks and the development of AI investments create uncertainty. During the autumn, investors’ attention will especially focus on whether economic growth will continue strongly and how the central banks will respond to inflationary and interest rate pressures.
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