US - NYSE

5

OVERVIEW

Amidst a challenging backdrop of high inflation, rising interest rates, geopolitical conflicts and increased recession concerns, the NYSE has had an undeniably volatile start to the year, with the NYSE Composite Index being down -8.7% (as of the 8th of August). The NYSE is likely to continue to feel the weight of the Fed continuing to tighten monetary policy at an unprecedented pace, shrinking liquidity and slower overall growth; with the impact being more pronounced on speculative stocks.

This may be slightly offset by positive earnings season results, however markets are likely to remain volatile given that the US has technically entered a recession, shrinking an annualised -0.9% in Q2 and -1.6% in Q1.

However, the Federal Reserve has pointed to strength in the labour market to suggest that the US is not in a recession. In July, the unemployment rate fell to 3.5%, the lowest level in 50 years. The number of unemployed persons fell to 5.7 million, returning to pre pandemic levels. Labour shortages remain as a key production constraint, and are thus likely to weigh in on prices.

Policymakers face tougher trade-offs between sustained growth and inflation in the short term. The pressure to live with inflation is likely to remain high on the Fed’s considerations as debt levels surged to fund the fiscal response to the pandemic and corporate and household debt servicing costs remain elevated after an era of low rates - creating higher sensitivity to rate increases. The Fed appears to be accepting lower growth to tame inflation (headline inflation is sitting at 9.1% as of June 2022) in the medium term. The market may be under-appreciating that price pressures are likely to persist, with high energy costs likely to be sticky as global commodity prices remain high. The energy index rose 7.5% in June, contributing to nearly half of the CPI’s rise. The contours of demand have also shifted from services to higher demand for goods, with personal consumer spending on goods (as a percentage of total nominal consumer spending) rising from approximately 31% in 2019 to 34.5% in 2022, though this remains below pandemic highs of almost 36%. Geopolitical tensions are likely to continue to weigh in on prices as global food and energy prices materially increase the cost of living in the US. Broadbased spikes in inflation are unlikely to have been priced in by markets, however the majority of the downside risk related to this macro-environment of persistently higher inflation and shorter economic cycles is likely to have been accounted for by portfolios.

EQUITIES

On the other side of the Pacific Ocean, US stocks have recorded their worst first half of a year since 1970, with the S&P 500 index falling 20.6% over concerns the Federal Reserve may be unable to engineer a soft economic landing. More recently, the S&P 500 rallied 9.1% in July in the best month since November 2020, largely due to robust corporate earnings and indications the Federal Reserve could slow the tightening of monetary policy. With inflation yet to peak and growth slowing globally, many experts warn recent gains are nothing more than a “bear market rally”. Nonetheless, a better-than expected US manufacturing report suggests that, despite a slowdown in growth, cost pressures on companies may be easing.

With the notable exception of the energy sector up 35% year to date amid elevated oil prices and years of underinvestment, there has been a sharp reset in investor expectations towards both cyclical stocks and highflying tech stocks. The forward price-toearnings ratio for the S&P 500 is around 18, down from 31 a year ago but still above the long-run average of about 16. As such, although the worst is likely over, technology and other growth stocks continue to be at risk of multiple contraction.

The question now is whether US stocks are set to hit new lows in the second half of the year or whether we are at the beginning of a new bull market. In any case, the response of the Federal Reserve is expected to bring considerable volatility to US equity markets as the market sentiment continues to be very inflation-driven.

COMMODITIES

“The United States remains the world’s top oil consumer and producer, with oil consumption increasing at the fastest pace since 1976 last year and oil production hitting a post pandemic high of 12.2 million BPD. The Russia-Ukraine war ravaged energy markets earlier in the year as West Texas Intermediate crude futures, the US oil benchmark, soared above $130 per barrel. While the price of oil has recently dropped below $100 per barrel on fears a possible recession could lead to demand destruction, the market remains historically tight and susceptible to geopolitical tensions. Notably, JP Morgan has warned that global oil prices could more than triple to a staggering $380 per barrel if Russia inflicts retaliatory crude-output cuts. The United States is the largest exporter of agricultural commodities, valued at US$172 billion as of 2021. American agricultural commodities are dominated by corn and soybeans used as feed for the livestock industry, and the prices of both reached near record high earlier in the year amid supply concerns when Russia invaded Ukraine. In particular, benchmark soybean prices are up 75% since March 2020 as China rebuilds pig herds after African swine fever decimated its pork supply. However, we see recent falls in oil prices, a strong US dollar, hot and dry US weather and demand destruction amid a possible recession weighing on agricultural commodity prices over the next 6 months.

FX AND FIXED INCOME

“With the US entering a technical recession, 10-year US treasury bonds have shown a steady decrease following a 10-year high of 3.4% yield in June. Volatility in recent weeks reflects inflationary and expected jobs reports released in July, with wage growth earnings increasing over 5.2% over the last year - reversing falling 10-year yields from 2.5% to 2.8%. Despite the high treasury yields, investor sentiment continues to fall with analysts expecting further 75-basis point rate hikes in the coming Fed meetings.

Despite challenging geopolitical and inflationary environments, the US dollar has stayed strong against major currencies, reaching a 20year high in mid-July on the Dollar. The combination of the US dollar as a reserve currency and highinterest rates encourage foreign investors to seek a safe haven in times of instability, driving up the US dollar. However, recent moves within the past month have shown the DXY (U.S. Dollar Index) retreating with markets focused on July’s US CPI report.

RISKS

As arguably the most influential market globally, there are a number of risks associated with the US economy, which is likely to have ramifications for other countries around the world. The CPI index hit a 41-year high of 9.1% in June. Should inflation continue on this trend in the July CPI report, this could trigger more aggressive than expected front-loading from the already hawkish Fed, which has flowon impacts both for the short-term in equity markets both in the US and globally, as well as implications for the economy. With soaring inflation already placing downward pressure on household consumption and discretionary expenditure, higher mortgage servicing payments induced by increasing interest rates will only amplify this impact. With the US already in a ‘technical recession’ following two periods of negative GDP growth of -1.6% and -0.9% in Q1 and Q2 respectively, economists have been quick to point out that nonfarm payrolls data has been particularly strong, increasing by 528k, more than double the consensus number, with employment rebounding back to preCovid levels. However, the Fed’s current balance sheet run-off ‘quantitative tightening’ plan, through the sale of $2.2tn assets in the following three years, has the potential to equate to a 75 basis point increase in the Federal Funds Rate during periods of high economic uncertainty, and could result in over-tightening, sending the US economy over the tipping point into a full-blown recession.

To top this off, current US-China tensions have escalated further, with Nancy Pelosi’s recent visit to Taiwan sparking live military drills and firing of missiles, with already existing trade tariffs from the Trump administration which could worsen based on oncoming political events. This coupled with the current supply chain crisis, and food and energy inflation resultant of the Ukraine-Russia crisis, could also have the potential to increase imported inflation to a level unanticipated by the Fed and further increase recessionary risk.