David Darst’s August 2022 Market Recap

August started strong, continuing the July rally, but became volatile in the second half of the month.

The Federal Reserve announced it will keep raising interest rates, higher and longer than market expectations.

Inflation remains high despite a small decline, and the economy is still slowing down. The Family Office recommends diversification, risk mitigation by holding some cash, investing in private markets, and choosing a good investment manager.

Book an appointment with our financial advisors to start your investment journey.

Highlights:

The Federal Reserve (the “Fed”) remains committed to fighting inflation

The European Central Bank (ECB) is expected to continue rates hike

U.S. economy contracted at a more moderate pace than initially expected in Q2

Gas supplies via Nord Stream 1 have been stopped by Gazprom

Stocks drop after a partial recovery in July



Policy & Geopolitics

The Fed remains committed to fighting inflation

The Fed raised rates by 0.75% at its June and July meetings, and Jay Powell confirmed his unconditional commitment to fighting inflation at the Jackson Hole conference on August 27. The Federal funds rates range between 2.25% and 2.5%, their highest since December 2018, and is expected to range between 3.25% and 3.5% by year end. Keeping Fed funds rates moderately above neutral is expected to help put pressure on inflation.

U.S. Consumer Price Index (CPI) rose 8.5% year on year (YoY) in July, below expectations and at a slower pace from the previous month due largely to a drop in gasoline prices. The monthly CPI was flat as energy prices declined 4.6% and gasoline fell 7.7%. That balanced a 1.1% monthly gain in food prices and a 0.5% increase in shelter costs.

The central bank will finally begin unloading the Treasury bills it started amassing almost three years ago. September will be the first month that bills will be redeemed since coupons will fall below the new cap of the monetary authority. $43.6 billion of Treasury coupons held by the Fed mature in September, which means that $16.4 billion in bills must be divested. Another $13.6 billion must be divested in October. As a result, September and October should see the largest declines for bill holdings.

Sources: CNBC, CNN, Bloomberg

ECB expected to hike rates aggressively

Faced with the fastest inflation since the euro was introduced, the ECB raised borrowing costs for the first time in more than a decade last month, lifting its deposit rate by 0.5% to 0%. Cuts to Russian natural gas supplies and the resulting surges in energy costs are likely to drive inflation higher than previously expected and the resulting squeeze on household incomes may make a recession unavoidable. The market expects the ECB to raise rates by 0.5% in September (a higher 0.75% hike is possible). ECB board member Fabio Panetta warned that the ECB must exercise caution with further rate hikes as a looming recession may ease inflationary pressures, lessening the need for central bank action. HSBC expect the ECB to stop hiking interest rates after the end of 2022, when a recession in the region and easing price pressures restrain monetary-policy tightening. The ECB is expected to raise rates by 0.25% in October and December.

U.S. imposes more sanctions on Russia while Gazprom cuts European gas supplies

As the Russia-Ukraine conflict continues, Russia's state-owned energy firm Gazprom said that due to maintenance on the Nord Stream 1 pipeline there would be no gas flow to Germany for three days starting on August 31. Germany has accused Moscow of using energy as a weapon. Gazprom also said it would suspend gas supplies to France's main provider, Engie, as the French company  had failed to pay for all deliveries made in July. Russia has also cut supply to Bulgaria, Denmark, Finland, the Netherlands and Poland completely, and reduced flows via other pipelines in response to sanctions on Moscow following the invasion of Ukraine. This disruption comes at a time when the energy market is already strained and wholesale gas prices are soaring over 400% since last August.

Macro Indicators

Companies keep hiring

U.S. unemployment rose to 3.7% in August, largely due to the labor force participation rising to 62.4%, its highest level since March 2020. US added 315,000 jobs for the month, just below the Dow estimate of 318,000 and well below the 526,000 uptick of July. Professional and business services led payroll gains with 68,000, followed by health care with 48,000 and retail with 44,000.

US wages continued to rise, but slightly below expectations. Average hourly earnings increased 0.3% for the month and 5.2% YoY, both 0.1% below estimates.

Sources: Federal Reserve Bank of St. Louis, Eurostat

*US as of August 2022; Euro Area as of July 2022

Consumers shift away from services

The U.S. economy contracted at a more moderate pace than initially expected in Q2 as consumer spending mitigated the effect of a sharp slowdown in inventory accumulation. US GDP shrank at an annualized 0.6% last quarter, the government said in its second estimate of GDP. That was above the previously estimated 0.9% decline. The economy contracted 1.6% rate in Q1.

Consumer spending, which comprises around 70% of the U.S. economy, increased 0.1% in July, marking a slowdown from June when spending increased 1.1%. US consumers spent less on gasoline last month, reflecting lower prices at the petrol station.

Sources:, CNBC, Markit Economics, Eurostat, FRED, Reuters

Consumers also slowed spending on services and continued to spend on durable goods. Consumers have become more cautious as they faced economic disturbances, including supply-chain disruptions and rising interest rates which make borrowing more expensive. Personal income increased 0.2% in July, primarily reflecting higher compensation.

U.S. retail sales were unchanged in July, below the 0.1% estimate and below the 1% increase in June.

U.S. housing starts tumbled 9.6% to an annualized rate of 1.45 million units in July, the lowest since February 2021 and well below market expectations of 1.54 million.

The US CPI annual inflation increased 8.5% in July, below expectations and the 9.1% YoY increase in June. Core CPI, which excludes food and energy, climbed 5.9% YoY in July from a peak of 6.5% in March. Monthly US CPI was flat while core CPI increased 0.3%. Eurozone CPI reached a new YoY high at 9.1% in August, marking the ninth straight month of record consumer price increases.

The IHS Market Manufacturing Purchasing Managers’ Index (PMI) remained at 52.8 in August in the US and dropped to 49.6 from 49.8 in the euro area.

Sovereign bond yields rise amid investor concerns

U.S. 10-Year Treasury yields rose to 3.19% in August from 2.65% in July as investors weighed the prospects of a U.S. recession. Germany’s 10-year bund yields rose to 1.54% in August from 0.81% in July and -0.18% at the beginning of the year.

Source: Bloomberg

*As of August 31, 2022

Financial Markets

Equity markets fell in August

After partially recovering in July, US stocks fell in August. The S&P 500, Dow Jones and Nasdaq declined 4.24%, 4.06% and 4.64% in August, respectively. The threats of a looming recession and the strong message on interest rates from the Fed impacted risky assets.

The STOXX Europe 600 and UK FTSE100 fell       -5.29% and -1.88% respectively, in August. The Chinese SSE Composite Index and Hong Kong Hang Seng index fell -1.57% and 1.00%, respectively, while the Japanese Nikkei 225 Index rose 1.04%.

Credit spreads

Investment grade spreads tightened to 1.48% at the end of August from 1.53% at the end of July, while high-yield spreads widened to 5.03% from 4.83%.

Oil prices fall amid recession fears

Spot WTI and Brent crude oil prices fell from $98.62 and $103.97 per barrel, respectively, on July 29 to $89.55 and $95.64 on August 31 amid rising recession fears and  worries of demand destruction across the West as interest rates rise.

Source: Bloomberg

*As of August 31, 2022

Sources: Bloomberg, FRED, Reuters

OPEC+ agreed to increase output by 648,000 barrel per day (bpd) in July and August and decided earlier this month to raise production quotas by another 100,000 bpd in September as it faced pressure from major consumers including the US. But Saudi Arabia, the top producer in the Organization of the Petroleum Exporting Countries (OPEC) has raised the possibility of a production cut, which could coincide with an increase in supply from Iran if it reaches a nuclear deal with the West.

Governments across Europe are grappling with a cost-of-living crisis driven by Russia’s invasion of Ukraine and its subsequent cuts to gas supplies. Record gas prices threaten to send the region’s economy into a deep recession. Europe’s benchmark gas price has soared by almost a third in the last week of the month and European gas prices hit a record high above €343 per megawatt hour on August 26, showing the serious threat to energy-intensive industries.

Source: Bloomberg

*As of August 31, 2022

US dollar rises, gold and Bitcoin fall

The US dollar kept increasing and stayed well above 100, reaching $108.70 on August 31 from $105.90 on July 29. Meanwhile, gold prices fell -3.11% in August to $1711.04 as the Fed stays hawkish, while Bitcoin dropped 16% to $19,813.97 at the end of the month, more than 70% below its all-time high of $68,789.6 on November 10, 2021.

Sentiment

Improved consumer sentiment despite slower expected growth

The Consumer Sentiment Index of the University of Michigan increased 13% to 58.2 in August from 51.5 in July after a record low of 50 in June.

The VIX index increased to 25.87 at the end of the month from 21.33 in July.

The month-end Fear and Greed Index (which uses seven factors including market momentum, safe-haven demand, and junk bond demand) showed “Neutral” at 48 at the end of August, after showing “Greed” from August 1 to August 29.

COVID-19

The number of COVID-19 cases and deaths is rising as many countries drop restrictions during the summer.

With easing US restrictions during the summer, cases are rising again, with a seven-day average of 124,312 cases in July compared to 112,693 in June. The Centers for Disease Control and Prevention (CDC) believe infections are likely to be much higher as many at-home Covid tests elude the official data. The Omicron variant dominates new infections, causing around 95% of new cases. Public officials expect a larger wave of infection in the fall as immunity from vaccines fades. The U.S. has agreed a $1.74 billion deal to purchase 66 million doses of the new Moderna vaccine that targets Omicron, and a $3.2 billion deal for 105 million doses of updated Pfizer shots to battle the expected infection wave during fall.

Omicron cases have also surged in Europe through the summer as travel restrictions and mandatory testing requirements eased. Despite an explosion of Omicron cases throughout the continent, governments are not concerned as severe cases that crowd intensive care units have not increased.

China implemented a “zero-covid” policy in May to suppress the virus, using mass testing and lockdowns. The highly transmissible Omicron variant has strained that strategy, especially with the more infectious subvariants, as the seven-day average increased to 686 cases ending July, from 116 at the end of June.

The Month Ahead

1.Fed  meeting on September 20-21

2.ECB Monetary Policy meeting September 8

3.Potential oil supply cuts

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