Investment environment overview 07/2024

July was rich in events both on and off the financial markets. While the situation in the Middle East continued (and continues) to heat up, in the U.S. the Democrats decided to change their presidential candidate in the upcoming elections, although so far the benefits of replacing Joe Biden with Kamala Harris are difficult to fully assess. Some polls show that the positions of the Democrats are getting stronger, while others point to the lack of positive dynamics. At the same time, there was capital rotation in the U.S. equity market (it is hard to say whether this trend will be sustainable), and the reporting season has also started – so far, the companies of the S&P 500 Index show good profit figures, but a decrease in revenue growth rates. Central banks were not left out either: the Federal Reserve left rates unchanged but signalled a likely cut in September; the Bank of Japan raised rates from the 0-0.1% range to 0.25%, thereby strengthening the Yen (leaving market participants quite upset); and the Bank of England cut the Official Bank Rate by 25 basis points to 5.00%.

European and US equity markets

Source: Bloomberg and Signet Bank

The reporting season is in full swing

The S&P 500 Index ended July with a modest 1.1% gain, although it did hit an all-time high in the middle of the month, reaching the 5,669.67 mark. At the same time, the Dow Jones Industrial Average added 4.3% and the Russell 2000 rose as much as 11.0%. The growth of the latter caused talks about a massive flow of funds from the expensive technology sector (the Nasdaq-100 lost 1.6% in July) into the shares of small and medium-sized companies. The main reasons for this reallocation are believed to be the imminent start of the rate cut cycle and the “soft landing” of the economy. We will refrain from buying recommendations for now – the “soft landing” scenario does not seem that obvious to us.

The reporting season is going relatively well so far. At the time of writing, 75% of the S&P 500 companies have reported their numbers. 78% of companies had their EPS growth exceeding market expectations, and it is still above the 5-year (77%) and 10-year (74%) averages. The situation is worse with sales figures – only 59% of companies managed to beat market expectations, compared to the 5-year average of 69% and the 10-year average of 64%. It is also worth noting that this time the market is harsher when “punishing” companies that report worse than forecasts.

Benchmark 10-year bond yields

Source: Bloomberg and Signet Bank

Anticipating volatility

Though dollar weakened slightly against the euro and was also declining relative to other currencies, Forex market remained rather passive – in EUR currency pairs volatility was exceptionally low by many measures. Such periods are usually followed by volatility spikes and (eventually) with strong directional moves. We are still in the mentioned EUR/USD 1.06-1.10 range trade, looking for directional clues and bearing in mind that quite a few stop orders are put around 1.04 area. Any move above EUR/USD 1.10 mark would be a red flag for us.

Gold had a good month of July, but gave up some of the gains in early August. We see bullish trend here as intact and have set our next XAU/USD target at 2600. Silver was volatile and rather disappointing, trading in the $28-$31 range. As investors anticipate Fed rate cuts in September, it could reduce the opportunity cost of holding gold and other precious metals. Again, we advise to stick to strict risk management rules when dealing with precious metals (and other commodities) and be prepared to 10-20% price swings.

It seems that natural gas has established a price range between “cheap” and “very cheap”, so we are comfortable with our long positions in the commodity. Crude oil was trading at around $78-$82 per barrel and still remains a puzzle for us, with market shaping itself for the next directional move. We expect some volatility spikes and are watching how prices will react as “Venezuelan situation” and other political dramas unfold.

High Yield bond Indexes

Source: Bloomberg and Signet Bank

Manufacturing is still weak, services help

Eurozone’s manufacturing experienced yet another setback in July. The two biggest economies in the currency bloc, France and Germany, saw their manufacturing indices values fall to six- and three-month lows respectively. The only two nations included in the poll to have an increase in their Manufacturing PMI were Italy and Ireland. Still, the seasonally adjusted HCOB Composite PMI Index was in expansionary territory, though dropping from June’s 50.9 to 50.2, while HCOB Services PMI Index was down from 52.8 to 51.9. The euro area’s input cost inflation trend has accelerated. Both manufacturers and service providers saw faster rises in operating costs, albeit the latter still faced the most pressure. According to Eurostat, annual inflation in July stood at 2.6%, which is marginally higher than June’s reading of 2.5%.

According to the ISM, U.S. Manufacturing PMI decreased by 1.7 points to 46.8 in July. The six manufacturing industries registered growth in new orders, while eight reported decline. Of 18 industries, only two reported employment growth in July. On the other hand, Services PMI indicated notable sector expansion for the 47th time in 50 months, coming in at 51.4. The Business Activity Index increased by 4.9 points to 54.5. Eleven industries indicated a rise in commercial activity, while only 3 reported a slowdown. According to Bureau of

Labor Statistics, annual unemployment rate in the U.S. was 4.3% in July, which was a negative surprise. Even worse, Non-Farm Employment Change was weak at 114k, far worse than expected (176k), with June numbers revised to 179k from 206k.

In July, the official Manufacturing Purchasing Managers’ Index for China decreased slightly from 49.5 to 49.4, according to the numbers released by the National Bureau of Statistics. Non-manufacturing PMI also showed a slight decrease from 50.5 to 50.2 points. Real GDP figures for the second quarter (compared to the same quarter of 2023) were also disappointing, coming in lower than expected at 4.7% and lower than Q1 reading of 5.3%.

Gold price, USD/oz

Source: Bloomberg and Signet Bank

The market is set for the interest rate cut

According to the Investment Company Institute data during July there was an outflow from equity funds, totaling 59.5 billion dollars (cumulative outflow for the month). At the time of writing, the S&P 500 Index is showing a significant decline (-9.6% from its peak values), which accelerated in early August. We continue to believe that the decline could reach the 4950 zone in the short term, and if these levels will be broken, we could see bears attacking 4700 area (though it is too early to talk about it now).

The decline in U.S. Treasury yields in July was due to pressure from the equity market and economic data. As expected, the Federal Open Market Committee left the interest rate unchanged at its last summer meeting, but signalled a likely cut in September. The futures market is already expecting 4.25% interest rate levels by the end of the year, and further cuts to 3.00% by October 2025. This assessment is broadly in line with our view of what is happening and we continue to recommend increasing positions in longer duration benchmark securities. Ongoing tensions in the Middle East (and not only there) could make an “escape” into low-risk assets even more attractive and probable, and we would not be surprised if our target levels for long-term government debt yields are reached within the next 2-3 months.