Monthly Market Update | July 2021

Overview

1. 1. Central banks remain dovish despite inflationary signs

2.  

3. 2. US economic growth is slower than expected

4.  

5. 3. Equities continue rise in low-rate environment

6.  

7. 4. Sentiment declines amid inflation concerns

8.  

9. 5. Vaccination progress continues, but Delta variant spreads

10.  

11. 6. Technology and financials outperform, energy recovers

12.  

13. Policy & Geopolitics

Central bank policy unchanged

During his semiannual economic testimony to the House Financial Services Committee and the Senate Banking Committee on July 15, Federal Reserve (“Fed”) Chairman Jerome Powell indicated that easy monetary policies will not change, and ample warning will be given before tapering begins. Despite inflation being higher than expected inflation, Powell expects prices to ease later this year as pandemic-related supply shortages moderate and the constraint on supply eases. Since March 2020, the Fed has maintained interest rates near zero, targeting inflation moderately above 2%. On July 28, the Fed improved their assessment of the economy slightly, citing progress with low unemployment and stable inflation, despite the pandemic. This indicated that the Fed may reassess its monetary policy in coming meetings.

On July 13, Senate Democrats agreed on a reduced $3.5 trillion spending budget, well short of the $6 trillion package proposed earlier this year. Lawmakers and the White House are also working on a $1 trillion infrastructure plan, cutting President Biden’s original $2.3 trillion offer to Senate Republicans. Democrats and Republicans continue to negotiate a bipartisan infrastructure plan to finalize an agreement by month end, but continued disputes over the size of public transit funding threatens to delay the already late infrastructure bill.

On July 8, the European Central Bank (the “ECB”) announced a new policy framework that will likely maintain easy monetary policy longer, changing the inflation target to 2% from “just below 2%” and keeping interest rates at -0.5% as Delta COVID-19 cases surge. Although inflation is rising in the US, it remains low in the eurozone despite easy monetary policy. At a news conference on July 22, ECB President Christine Lagarde said that the Delta variant may “dampen recovery in services, especially in tourism and hospitality.” Lagarde also stated that the ECB does not plan to change its €1.85 trillion emergency bond-buying program.

President Biden’s $4 trillion budget deal

On July 13, Senate Democrats unveiled a trimmed $3.5 trillion package for antipoverty, education, childcare and climate change spending over the next decade after several rounds of negotiations between progressives who proposed a $6 trillion package and moderates who preferred a smaller $2 trillion deal.

The $3.5 trillion package is accompanied by $1 trillion in infrastructure spending on the electrical grid, transit, roads, bridges, etc.

The deal will include paid family and medical leave, subsidized childcare, an extension of an expanded child tax credit and affordable housing, among others.

The proposal raises the corporate tax rate from 21% to 28% and the top capital-gains rate from 23.8% to 43.4% to cover the cost of the spending package over 15 years.

Macro Indicators

Labor market recovery continues

The US labor market recovery is accelerating after slowing earlier this year. Unemployment edged to 5.9% in June from 5.8% in May, reflecting higher labor-force participation as more people start seeking jobs while employers still struggle to fill job vacancies. Non-farm payroll rose by 850,000 in June, the strongest growth in 10 months as businesses react to the accelerating economic recovery and labor supply constraints ease. Weekly initial unemployment benefit claims fell by 24,000 in the week ending July 24 to 400,000. May 2021 euro area unemployment dropped to 7.9% from 8.1% in April, the lowest since May 2020, as the labor market recovers slowly amid the easing restrictions.

Growth continues but a slowdown is expected

Annualized US GDP grew 6.5% in Q2 2021, slightly above the revised 6.3% in Q1 but below the 8.4% forecast. With business reopening, widespread vaccinations and government aid, the growth confirms that the US economy has overcome the pandemic, but the slowing pace indicates an incomplete recovery. Following an 11.8% annualized increase in consumer spending, US growth is expected to ease gradually this year with growing threats of COVID-19 variants, inflation, supply chain disruptions, and worker shortage.

US retail sales rose 0.6% in June, following a decline in May, underpinned by continued vaccinations, low interest rates, and fiscal stimulus.

Existing U.S. home sales rose 1.4% in Q2 to a seasonally adjusted 5.86 million annually. Continued strong demand pushed home prices to a record high in June, although the boom is beginning to ease slightly as rising prices tempt more homeowners to sell their houses.

Based on preliminary Eurostat data, the eurozone economy in Q2 2021 grew 2% over Q1 and 13.7% year on year (YoY) after two quarters of contraction as COVID-19 restrictions eased and vaccinations accelerated. The euro zone economy remains about 3% below the pre-pandemic level and further recovery is dependent on controlling the Delta variant as infections surged in many countries.

The Consumer Price Index (CPI) increased 5.4% YoY in June, the highest yearly increase since August 2008. Core CPI, which excludes food and energy, climbed 4.5% YoY and 0.9% from May. The large gain was driven by booming consumer demand amid supply shortages and price recovery in hard hit service industries such as air travel, hotels, car rentals, entertainment and recreation. Widespread vaccinations, easing restrictions and abundant savings further boost consumer demand. CPI in the euro area increased 1.9% YoY in June, slowing from a more than two-year high of 2.0% in May, while core inflation fell to 0.9% from 1.0% in May.

The IHS Markit US Manufacturing Purchasing Managers’ Index (“PMI”) rose to a record 63.1 in July from 62.1 in June while the Euro Area Manufacturing PMI fell to 62.6 in July from  a record 63.4 in June.

Sovereign bonds yields fall amid COVID-19 concerns

On July 19, 10-year US Treasury yields dropped to the lowest levels since February 2021, from 1.30% at Friday’s close to 1.18% on Monday, marking the biggest one-day decline since March 2020 amid concerns over the highly contagious Delta COVID-19 variant. This indicates that markets are less worried about inflation than about the pace of economic recovery. 10-year inflation expectations, measured by Treasury Inflation Protected Securities, remained high at 2.35% in July but below their 2.54% peak in May (highest since 2013). On July 26, Germany’s 10-year bund yields fell to a more than five-month low of -0.45%, amid concerns over the Delta variant and supply chain constraints

Financial Markets

Equity markets shake off fears of rising rates

US equity markets rose in a volatile July, dominated by concerns over inflation, the Delta variant, Fed tapering and corporate earnings. On July 19, the Dow fell 2.1%, its worst day in nine months, and the S&P 500 fell 1.6%. Stocks rebounded thereafter with the S&P 500 recording its best day in almost four months, finishing the month up 2.3% for a six consecutive month of gains. The Dow and the Nasdaq rose 1.3% and 1.2%, respectively, in July.

European equity markets also rose in July, with the STOXX Europe 600 and the UK FTSE100 rising 2.0% and 0.2%, respectively. In Asia, equities fell at month-end amid rising concerns over the Delta variant followed by tightening restrictions as cases surged. The Hong Kong Hang Seng index, the Chinese SSE Composite Index and the Japanese Nikkei 225 Index fell 9.9%, 5.4% and 5.2%, respectively.

Credit spreads widen as investors worry about COVID-19

Investment grade spreads widened to 0.91% at the end of July from 0.84% in June amid worries about the effect of the Delta variant on economic recovery. High-yield spreads rose to 3.23% from 3.03% in June but remained well below the levels earlier this year. First-lien and second-lien spreads to maturity widened to LIBOR + 4.09% from LIBOR + 4.03% and LIBOR + 7.12% from LIBOR + 7.09%, respectively. The yield-to-maturity of first- and second-lien debt remains below year-end 2019 levels due to near-zero interest rates and unprecedented Fed support for the fixed income market.

Oil price recovery continues at a slower pace

Spot WTI and Brent crude oil prices increased from $73.47 and $74.62 per barrel, respectively, in June to $73.95 and $75.41 at the end of July, as rising energy demand, strong earnings, and continued vaccination reduced the risk of a global resurgence of COVID-19.

Earlier this month, OPEC Plus agreed to raise output by 400,000 barrels a day each month until the end of 2022, which would continue to rein prices as demand increases.

US dollar climbs, gold eases, and Bitcoin falls

After reaching a four-month low of 89.6 against a basket of currencies on May 25,, the ICE US dollar Index climbed through June and July. The US dollar rose to a more than three-month high of 92.97 on July 20 as the economic recovery raised expectations of tapering by the Fed, before falling to a one-month low of 91.91 on July 29 after the Fed stated that it will not begin tapering soon. Meanwhile, gold rose to a two-week high of $1,795 on July 2, driven by accommodative Fed policies, fiscal stimulus and inflation. Gold rose 2.6% to $1,817 per ounce at month end. Bitcoin dropped to $29,609 on July 20 for the first time in a month, before rising to $41,870 at month-end, the highest since May. The rally continued amid support from Tesla CEO Elon Musk and Ark Investment Management LLC’s Cathie Wood.

Earnings

Technology delivers strong earnings; Amazon misses

Apple revenues increased 54% YoY in Q2 to $89.58 billion, 16% above estimates, while earnings per share (EPS) of $1.40 were 41% above estimates, with double-digit growth in all product categories. iPhone sales rose 66% YoY and iPad and Mac sales grew 79% and 70%, respectively. Apple CEO Tim Cook said that Q2 results suggest that the pandemic-driven boost may continue as economies open.

Amazon revenues exceeded $100 billion in Q2 for a third consecutive quarter but were below expectations. Q2 2021 EPS of $15.12 were 23% above estimates while revenues of $113.08 billion were 2% below estimates. Q2 2021 revenue grew 27% YoY, significantly below the 41% growth in Q2 2020. Amazon CFO Brian Olsavsky attributes this to the exceptional performance during the COVID-19 lockdowns. Andy Jassy replaced Jeff Bezos as CEO in July.

Facebook beat estimates but warned of a significant slowdown in YoY revenue growth in the second half of the year. Sales grew 56% YoY to $29.1 billion, the fastest since 2016 and beating estimates of $27.9 billion. EPS of $3.61 were above the consensus estimates of $3.03. Increased pressure is expected from regulatory and platform changes, such as iOS privacy updates. Also, the Federal Trade Commission filed an antitrust complaint against Facebook, along with 48 other cases by state attorneys general, which was dismissed by a federal court. Facebook was criticized by the Biden administration for not combatting misinformation relating to the COVID-19 vaccine.

Alphabet revenue of $61.9 billion in Q2 was 10% above consensus estimates, while EPS of $27.26 were 41% above estimates. The advertising segment rebounded with a 69% YoY increase in revenue, after being impacted by the COVID-19 pandemic. YouTube revenues increased 83% YoY in Q2 to $7 billion. Alphabet CFO, Ruth Porat, said that the revenue trend in Q3 should be more muted.

Microsoft revenues of $46.2 billion and EPS of $2.17 were 4% and 13% above expectations, respectively. Revenue from the Azure cloud business grew 51% in Q2. Productivity and Business Processes, which includes Office products and LinkedIn, grew 25%.

Tesla net income surpassed $1 billion for the first time in Q2. EPS of $1.45 were 48% above consensus estimates of $0.98 per share and revenue of $11.96 billion was 6% above estimates, nearly doubling revenues YoY. Q2 revenue was driven largely by robust growth in the semiconductor shortage was mitigated by switching software for chips made by new suppliers.

Financials deliver strong earnings, signaling recovery

JP Morgan and Citi beat consensus estimates by 18% and 45%, respectively, as they released $1.1 billion of loan loss reserves made during the pandemic following the improved US economic outlook. JP Morgan revenues of $31.4 billion exceeded the $29.9 billion forecast, while Citi revenues of $17.47 billion exceeded the $17.2 billion forecast.

The EPS of Morgan Stanley and Goldman Sachs exceeded estimates by 12% and 47%, respectively, as their trading and market-making operations continued to be resilient during the pandemic. Goldman revenues of $15.4 billion exceeded the expected $12.2 billion, driven by the second highest quarterly revenue from investment banking amid a booming IPO market. Morgan Stanley revenues of $14.8 billion beat estimates of $13.9 billion, also driven by $2.38 billion of revenues from investment banking.

The performance of Visa, Mastercard and American Express was stronger than expected, confirming the economic recovery. Visa revenues of $6.1 billion were above the expected $5.9 billion while the EPS of $1.49 exceeded the expected $1.35. Mastercard revenues of $4.5 billion also exceeded the expected $4.4 billion while the EPS of $1.95 was above the Wall Street estimate of $1.75.  American Express revenues of $10.2 billion exceeded analyst expectations of $9.6 billion while the EPS of $2.80 was well above the expected $1.62.

Energy and Industrials return to profitability

Large energy companies, such as Exxon and Chevron, reported profits for a second consecutive quarter as global economic recovery increased demand and continued to increase prices.  Both companies remain cautious over capital spending and cost reduction.

The revenues of Caterpillar, often considered a barometer for an economic cycle, of $12.9 billion were above the estimated $12.5 billion with the EPS of $2.60 exceeding average analyst estimates of $2.41.

Sentiment

Consumer sentiment falls, market shows fear

The Consumer Sentiment Index of the University of Michigan fell to 80.8 in the first half of the month, the lowest since February, amid concern over inflation. By month end, the index rose to a 17-month high after positive economic data.

The VIX index surged to 22.5 in May amid inflation concerns before subsiding to 18.24 at month-end from 15.83 in June.

The month-end Fear and Greed Index (which uses seven factors including market momentum, safe-haven demand, and junk bond demand) showed “extreme fear” at 24.  Safe haven demand and stock prices show fear as investors flee risky stocks for the safety of bonds.

COVID-19

As of July 28, global COVID-19 confirmed cases were 195,266,156 with 4,180,161 confirmed deaths. 3.8 billion vaccine doses have been administered globally. The spread of the contagious Delta variant, first identified in India, led to a global surge in daily COVID-19 cases.

The Delta variant represented about 83% of new infections in the U.S. with unvaccinated people accounting for most of the severe cases. Cases are surging in 49 states. The US Centers for Disease Control and Prevention recommended that fully vaccinated people return to wearing masks in public indoor spaces. Dr Anthony Fauci, the top federal infectious disease expert, said that lockdowns are not expected but the situation will likely deteriorate, leading to more COVID-19 cases and deaths.

In Europe, governments continue to encourage vaccinations by introducing restrictions on the unvaccinated, such as indoor dining and gym access. European governments are issuing vaccination “passports” to identify the unvaccinated. The Delta variant has become the most dominant strain across the region.

Southeast Asia is the global epicenter of the COVID-19 pandemic as the Delta variant has led to record infections and deaths. During the first wave of the pandemic in 2020, Southeast Asian countries such as Vietnam and Thailand avoided widespread infections and maintained better control over the virus than the rest of the world. Now, the region is struggling to contain the virus with low vaccination rates and limited medical supplies. Indonesia has surpassed India and Brazil as the country with the highest rate of new infections.

The Month Ahead

1. Global vaccine rollout

2. President Biden’s $4 trillion budget proposal

3. Fiscal stimulus in the US and Europe

4. Delta COVID-19 variant

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