'Bad News Is Good News' Rate Hopes Spur Equity Rally In July

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Summary

  • After months of battering, global equity markets enjoyed a reprieve in July, lifted by hopes that worsening economic signals and falling commodity prices might give central banks, led by the Fed, some leeway to dial back their tightening campaigns.
  • Despite their recent outperformance, US and European markets continued to trail the global index for the year through July end, while the UK and Japan held their YTD and 12-month leadership, despite losing ground to the world index in July.
  • Central bank rate-hiking resolve, even in the face of plunging commodity prices and rapidly deteriorating economic data, sent long bond yields tumbling.

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By Mark Barnes, PhD, and Christine Haggerty, Global Investment Research

After months of battering, global equity markets enjoyed a reprieve in July, lifted by hopes that worsening economic signals and falling commodity prices might give central banks, led by the Fed, some leeway to dial back their tightening campaigns.

As we outline in our latest GIR Performance Insights report, any of this year's worst-performing markets this year led the upsurge last month, most notably US and growth stocks. The badly beaten-down Russell 2000 and Russell 1000 indexes climbed 10.4% and 9.3%, respectively, significantly shaving their deep year-to-date losses. The story was much the same for the FTSE Europe ex UK.

All three indexes outstripped the gains of the FTSE All-World and those of other major markets, particularly Japan and the UK, which have held up best through this year's punishing selloff.

Global equity market returns - one month ended July 31, 2022 (TR, local currency %)

Global equity market

FTSE Russell. Data as of July 31, 2022. Past performance is no guarantee to future results. Please see the end for important disclosures

Reading the tea leaves

Risk sentiment remains fragile, and one month does not a regime-change make. (Indeed, in a 'good news is bad news' twist, the stronger-than-expected US job gains reported on Friday dampened expectations for an earlier Fed pivot.) Still, examining the main influences behind the July bounce-back offers some useful clues for navigating the uncertainties of continued central-bank tightening in the months ahead, as well as for identifying the potential longer-term winners and losers once monetary tightening cycles ultimately end.

Despite their recent outperformance, US and European markets continued to trail the global index for the year through July end, while the UK and Japan held their YTD and 12-month leadership, despite losing ground to the world index in July.

Regional index returns relative to FTSE All-World (rebased, TR, LC)

Regional Index returns

FTSE Russell. Data as of July 31, 2022. Past performance is no guarantee of future results. Please see the end for important legal disclosures

Growth-stock exposures drive divergences

As we've written in earlier blog posts (here) and (here), much of the pain suffered by the US market can be traced to its outsized exposure to the massive unraveling of expensive Technology and other high-growth stocks this year, coinciding with the spike in interest rates and extreme risk-off sentiment.

This and the US market's smaller exposures to resilient defensive groups (Staples and Telecom) and to beneficiaries of the war-fueled commodity price boom (Materials and Energy) have contributed significantly to US underperformance relative to global peers. This was especially true versus the UK, with its negligible Tech weight.

FTSE USA vs FTSE All-World ex USA industry weights (%) as of July 31, 2022

FTSE USA

FTSE Russell. Based on Industry Classification Benchmark (ICB) data as of July 31, 2022. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

But risk sentiment took a sharp U-turn in July, igniting an abrupt shift in market and sector leadership. Central bank rate-hiking resolve, even in the face of plunging commodity prices and rapidly deteriorating economic data, sent long bond yields tumbling. Downtrodden growth stocks enjoyed a strong resurgence globally, while reflation beneficiaries and first-half defensive winners lagged.

Industry-weighted contributions to July 2022 returns - US, UK, and Europe ex UK

Industry-weighted contribution

FTSE Russell. Based on Industry Classification Benchmark (ICB) data as of July 31, 2022. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

As shown below, bigger rebounds in sectors within Technology, Consumer Discretionary and Health Care led US outperformance over non-US peers last month.

FTSE USA sector returns relative to FTSE All-World ex USA sector returns (rebased, TR, LC)

FTSE USA

FTSE Russell. Based on Industry Classification Benchmark (ICB) data as of July 31, 2022. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

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