Primas Insights – July

Market Rallied…Now What?

Let’s start by looking at the information we have on hand. From a macro perspective, the majority of the data/events that came in July were rather negative. On the inflation front, US CPI at 9.1% was much worse than expected and the same goes for inflation in Europe. US housing data was deteriorating while consumer-related data was also disappointing along with negative guidance from Walmart. In Europe, the ECB surprised the market by hiking 50bps vs. 25bps expected amid European PMIs showing rapid deterioration. In emerging markets (EM), we continue to see protests across multiple EM countries but the highlight in EM was China with exceptionally disappointing GDP figures while there were also headlines of a banking crisis and renewed lockdowns in selected regions. Of course, geopolitics remains at the forefront with Russia vs. Ukraine still lingering and the conflict between US and China is certainly turning worst post the recent developments in Taiwan.

The list goes on and on, but let us stop here and look at something more positive. To start, the market took it exceptionally well that Russia did not immediately shut off gas to Europe. Next, US earnings were decent with almost 75% of companies having beaten estimates. Perhaps the most important point was the noticeable decline in inflation expectation and other indicators such as lower shipping costs which led many to believe inflation has now peaked. (Figure 1 & 2) The July FOMC meeting was taken as dovish given Powell’s mentioning of “neutral” and markets think the Fed has now pivoted from aggressive monetary tightening. In sum, markets took these very positively and bulls absolutely took control.

To us, however, we believe investors were rather complacent about some of these macro developments. In terms of Russian gas, the current flow to Europe is now limited to less than 20% and Russia is threatening to shut off entirely heading into winter. As such, there’s a very high chance Europe is heading into a winter gas crisis. In terms of US earnings, despite the bravos in the numbers game between company CFOs and wall street analysts, there was plenty of negative guidance from bellwether companies such as Caterpillar suggesting further demand drops, no improvements in supply chains, and no moderation in cost pressures. Last but not least, markets might have gotten ahead of themselves thinking monetary tightening will soon be over. As of this writing, the market is expecting the Fed fund rate to decline as quickly as Q1’23. This is very different from the previous dot plots and as Powell mentioned himself, policy actions going forward will be “data dependent”. To us, there is not enough evidence to suggest we will see monetary easing (i.e. goldilocks) that soon – the Fed might stop hiking/hold but it is unlikely they will cut immediately. Note in recent days, various Fed speakers have already come out hawkishly to push back on “neutral.”

With risk management being our top priority, we await better timing before we capture this golden dislocation opportunity.?

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