Overview
July began with a resurgence of tensions between Iran and the US. The June ceasefire started to show cracks at the beginning of the month. Iran attacked commercial vessels on the 7th, with an immediate US counterattack. The conflict continued to escalate, pushing Brent Crude prices back above $100/barrel on the 23rd. This increased energy prices and provided a tailwind for commodities returns, which ended the month at 7.5%, tracked by the Bloomberg Commodity Index. Afterwards, the market assessed a low risk of further escalation and the focus shifted back to AI, including 2nd quarter earnings, and the sustainability of the recent momentum.
Earnings season, which kicked off in mid-July, set the tone of investors continuing to be selective about where future profitability would concentrate. While several hyperscalers stayed relatively resilient, semiconductor companies faced significant downside pressure, as concerns over increased export controls and China’s recent progress in its technological capabilities caused the high valuations of these companies to be questioned. The sell-off was further amplified by forced deleveraging among some hedge funds.
Strong gains in energy and financials saw value stocks increase by 3.6%, outperforming growth, which retraced 2.5%, as the technology sector underperformed. This was tracked by the MSCI World Growth and the MSCI World Value indices.
Fixed income markets reflected investors recalibrating on the outlook for inflation and interest rates. The increase in energy prices and data showing continued global economic resilience caused global government bond yields to rise over the month.
The Federal Reserve’s decision to hold rates did little to ease markets, as Kevin Walsh’s confusing FOMC Meeting left markets in doubt that the Federal Reserve is living up to its mandate to control inflation. This caused long term bond government bond yields to rise and yield curves to steepen, with corporate bonds weakening as well.
Stocks and Commodities
Equity markets showed inconsistent returns across regions, driven by their sector composition. This revolved around the month’s themes of oil prices, interest rates, and AI sentiment. UK equities stood out with the strongest reginal performance. It was supported by the heavy weight of its index in energy and financials, two sectors that greatly benefited from the rebound in oil prices and rising bond yields. The UK FTSE All-Share index gained 3.7% over the month.
In Japan, the TOPIX index finished flat, with its exposure to domestically oriented companies, industrials and financials, balancing out it’s underperforming technology exposure. In contrast, the Nikkei 225, heavily concentrated in technology and semiconductors, faced downside pressure, falling almost 8%.
European equities exhibited similar behavior to the Japanese TOPIX, with its composition a balance of the outperforming financial and industrial sectors, and the underperforming technology sector. This caused the MSCI Europe ex-UK index to end the month flat at 0.1%.
The S&P 500 also delivered a flat performance, despite second quarter earnings being exceptionally strong. As of the beginning of August, earnings growth is on pace to rise 36% year over year, and an unusually high 85% of companies have exceeded analysts’ expectations, even with analysts continuing to move their estimates up over the quarter. However, the reported earnings growth has come with caveats. Three quarters of it was concentrated in the technology and communications service sectors, and the numbers were propped up by one-off investment gains at several hyperscalers.
In addition, many large cap technology firms’ stock prices failed to rally after strong earnings reports, with the market scrutinizing the large amount of CAPEX spending still going into AI infrastructure development, demanding confirmation that there will be a return on investment. Companies are increasingly looking at debt financing to continue the build out.
Canadian equities delivered the second best regional performance, running behind the UK at a 1.2% gain for the S&P/TSX index. The rally in oil prices helped the relatively heavy weighted energy sector, ending the month with a gain of 6.9%. The financial sector, which also carries a heavy weight, came behind at 6.2%. While valuations are high, the Canadian banks have had a strong second quarter and continue to show strength. Earnings growth has been strong and the markets are predicting continued upward revisions of analyst estimates over the next 12 months. Signs of an improving Canadian economy along with Interest rate increases continue to provide a tailwind. The worst sector lags were communication services, along the global theme of AI cautiousness at -3.3%, and Materials at -3.1%, with precious metal prices remaining flat for the month.
The weakest regional performance came from Emerging Markets, with heavy exposure to the semiconductor manufacturing supply chain. The MSCI EM Index was down 3.0%, and the MSCI Asia ex-Japan Index decreased by 3.2%. Concerns surrounding large progress in China’s advanced chip technology triggered large selloffs in South Korean and Taiwanese semiconductor giants, with investor leverage pushing the declines even further. While China’s contribution to the Emerging Market index was a strong 9.0% over the month, it was offset by South Korea’s and Taiwan’s weak performances, down 17.1% and 5.3%, respectively.
Commodities rose sharply, driven by oil prices. WTI increased by 22.1%, attributing to the gain of 7.5% in the Bloomberg Commodity Index and 12.6% in the more heavily energy weighted GSCI Commodities index. Gold remained flat at .3%, while copper posted a modest gain of 3.6%.
Bonds
Global bond returns for the month were slightly negative, as government bond yields climbed steadily and credit spreads widened. Investors reassessed the outlook for inflation and interest rates from rising energy prices and data showing the global economy remained resilient. Even though major developed-market central banks held policy rates unchanged, the tone remained hawkish and the focus has been on dealing with inflation.
Japanese government bonds outperformed relatively, delivering a .7% loss over the month, according to the Bloomberg Japan Aggregate bond Index. Due to a pullback in the USD vs the yen, the resulting USD return was a positive 1.3%. The bonds were volatile however, as yields initially rose after the government announced additional fiscal stimulus before reversing.
In the United States, treasury yields moved higher across the curve despite the Federal Reserve leaving rates unchanged. Between strong economic data, rising energy prices, and minimal forward guidance from the Fed, the markets pivoted to expecting tighter monetary policy going forward. This resulted in long term yields increasing and the US yield curve steepening. The Bloomberg US aggregate bond index declined 1.3%.
Canadian fixed income was in line with global declines, posting it’s worst monthly performance since March. Corporate bonds declined -1.2% and Federal government bonds declined -1.3%. With the long end of the yield curve facing the biggest increase in yields. The ICE Canadian Long term bond index declined 3.8%. Pushing the ICE Canada Universe Bond Index down 1.6%, from concerns over rising US inflation and energy prices.
All major tracked countries in the euro zone experienced declines between 1–2%. The Bloomberg Euro Aggragate bond index decreased 1.5%, in local currency terms. Italian government bonds saw the sharpest rise in 10-year yields. The move reflected an increased sensitively in Italian debt vs other European bonds to macro-economic conditions, as investors increased expectations that euro-area interest rates will move higher.
Duration was the main sensitivity in fixed income performance this month, as a shift in interest rate expectations weighed more heavily on longer-dated assets. While high-yield spreads widened more than investment grade, the shorter duration and higher carry of the asset class softened the impact. Notably, investment grade credit experienced larger losses than high yield, as increased borrowing from technology companies for AI infrastructure spending, with investment grade ratings, caused volatility in higher corporate credit quality.
Conclusion
July showed how quickly market sentiment can change as geopolitical tensions, sector rotations, and profitability expectations shift. A short-lived jump in oil prices reignited inflation concerns, pushing global bond yields higher, highlighting interest rate sensitivity to energy shocks. Equities experienced sector rotation, as investors shifted to a more careful stance on AI and semiconductors, refocusing on the viability of long term profitability. Value oriented sectors, such as energy, industrials, and financials benefited from these themes. This serves as a reminder of the importance of diversification.
