Following a strong rally in the first half of the year, August thus far has seen the markets give back some of those gains. This could simply be attributable to seasonal effects, rather than anything ominous. Historically, the best months for stocks have tended to be April, November and December, while June, August and September have been the worst. August is really just a quiet holiday month… rather than a worrisome investment month.
On Wall Street, the S&P 500 Index is down around 3% since its 31 July high. The NASDAQ, meanwhile, has retreated by just over 4% over the same period. The magnificent seven (Apple, Amazon, Alphabet, Meta Platforms, Microsoft, Nvidia and Tesla) are down approximately 5%.
Remember – those particular tech companies have led Wall Street in recent weeks. If they are taking a breather, then this is most likely a good thing, given the outsized gains they have delivered to investors.
Equity and bond markets were in shock midweek following credit rating agency Moody's downgrading of ten small to mid-sized US banks. A further six are now under review and are facing a potential downgrade. Although this is not being seen as a further banking crisis, the markets did wobble on the announcement.
August and September are often two of the most volatile months in the calendar year. A correction in the range of 5 to 10% should not be ruled out following such a strong rally.
We do not see a correction of that magnitude disrupting what we believe are the early stages of a longer-term bull market: inflation, interest rates and the wider economy are all continuing to support a better backdrop for the financial markets.
In the US, inflation is still trending in the right direction. This bodes well for a possible pause in the Fed's interest-rate tightening cycle. That said, the latest US CPI reading for July registered a marginal tick-up in inflation (up from 3% to 3.2%). Core inflation (which excludes food and energy) is, however, seen as the more important reading and came in at 4.7% – better than expected.
Given this relatively benign data, the Federal Reserve Bank might well consider a pause in its interest-rate hikes over the rest of the summer and into the autumn (unless there is an inflation shock in the coming weeks caused by the recent rise in crude oil prices).
With the US economy improving significantly and recording better-than-expected growth, the market has embraced the notion that a recession can now be avoided (and that growth might even be above trend for the year).
On the whole, the US market has priced in a lot of good news: better inflation trends, a pause in the Fed interest-rate hike, and a growing economy. A number of other factors might help drive the market higher, such as better corporate earnings news over the next two quarters.
There are also grounds for optimism on this side of the Atlantic. The UK economy actually grew faster than was expected in the second quarter, boosted by a recovery in car manufacturing and a strong June (which drew out customers and boosted the hospitality sector). UK inflation has also fallen sharply for the second month to 6.8%, now at its lowest level in 15 months.
Unfortunately, July's rainy weather and numerous strikes tempered that early enthusiasm and economic activity. There was, however, some good news for homeowners: the UK's largest mortgage lenders have started to cut their lending rates.
In Asia, China's post-Covid recovery continues to disappoint: recent data suggests that the country may actually be edging towards a period of deflation. This news will not be welcomed by the Chinese administration and it is likely to take further monetary and fiscal action in the near future.
Another potential fly in the ointment is the recent spike in energy prices: both crude oil and gas prices have risen – indeed, gas futures jumped almost 40% on Wednesday. The sector is grappling with concerns over possible supply disruptions, and now that OPEC has implemented and indeed extended its supply cuts, energy prices could increase further as we head towards winter.
The weeks ahead will most likely be delicate. However, the investors who did not fully engage in the recent rally will now be able to use any pullbacks or corrections as opportunities to add quality investments to their portfolios at lower prices.
There are still compelling long-term opportunities in equities and certain parts of the bond markets. As far as equities are concerned, the market looks set to broaden out as we head towards 2024. Lower inflation, interest rates and better corporate earnings trends will result in investors adopting a more global perspective in their investment strategies.
Geographically, we believe that the best investment opportunities are currently to be found in the UK, Europe, Southeast Asia and India. Perhaps more interestingly, though, the market now looks as though it is being driven by small-cap stocks and cyclical sectors, alongside AI and the wider technology sector (which still looks appealing for the long-term investor).
In the bond markets, short-duration and even cash-like instruments are currently favoured. With Treasury and gilt yields pushing higher, there might be a better entry point in the months ahead. But much will depend on central bank policy and how it evolves.
The bull market remains intact, but the forthcoming weeks could test it. We continue to view any significant pullbacks as further opportunities to add to your portfolio.
