The world continues to fight with inflation…

-Many countries in the world, especially US and Europe are trying to beat inflation. Some of the heavyweight central bankers, such as FED chair Jeremy Powell and the European Central Bank President Christine Lagarde underlined their goal to “beat inflation” and for that they will keep the interest rates as high and as long as necessary which dampened the market mood.

–As of August 25^th Bloomberg Global Aggregate Bond Index, the benchmark for global government bonds, was down by -0.8% on the month (bond yields and prices are inversely related; as yields go up, bond prices drop). Similarly Bloomberg Global Corporate Bond and High Yield Bond Indexes were also down on the month losing -1.2% and -0.85% respectively. This brought their year to date returns to 2.5% and 5.9% respectively.

–Global stock markets as well as the leading crypto currencies and commodities suffered from the negative market sentiment despite some good economic news in the US and Europe that pointed to soft landing as opposed to a full blown recession. The European Union (EU) unemployment rate announced on August 1^st which was 6.4% (same as end of June) and the US unemployment rate of 3.5% (vs. 3.6% in July) announced on August4^th both pointed to relatively stable and healthy labour markets.

–As of August 25^th the US equity index S&P 500 and European stock index Euro Stoxx 50 were down by -4% and -5.3% for the month, dragging their year to date returns to 14.8% and 11.7% respectively. The global equity markets suffered from the negative sentiment as well with the global equity indicator MSCI All Country World Index (ACWI) and the emerging market index MSCI EEM both down by -4.9% and -7.3% on the month respectively.

–After a very strong July with over 14% return, crude oil reversed some of its gains on the back of a jittery market environment due to persistent inflation and slowing economic activity. As of August 25^th first month futures contract for US crude oil WTI was down by -2.4% bringing its year to date return back to flat on the year.

–Gold also didn’t fare well in August. Over the same time frame the first month futures contract for Gold was down by -3.5% on the month, but managed to hang onto its gains from earlier in the year and delivered 6.2% return year to date. Gold prices have been partially buoyed by the strong global central bank demand for the precious metal since higher interest rates put a dent in the US Treasury returns.

–Similar to July, crypto markets continued to lose steam. As a result they continued to give back some of their earlier gains. As of August 25^th Bitcoin and Ethereum were both down by -11% on the month. While the cryptocurrency losses seem rather sizeable compared to equity and bond markets, this is expected given the higher risk and volatility in crypto currencies. As a result these negative returns are still small enough to make a dent in their year to date returns with Bitcoin still up 57.6% and Ethereum up 37.5% on the year.

–Turkish stock market had another sizeable monthly return in August with 7% return in local currency terms (8.5% in US dollar basis) as of August 25^th. This brought the index’s year to date return to 40% in local terms while almost fully offsetting the market’s year to date loss and bringing it to-1.25% in US dollar basis. Part of the reason for the monthly performance in US dollar basis being higher than the one in local terms was due to 1.5% appreciation in Turkish Lira against the greenback, first time since the end of 2022. This was partially due to the rate hike from 17.% to 25% by the Turkish Central Bank on August 24^th.

–What should investors do in such a market environment? One of the golden rules of investment is to avoid putting all eggs in one basket. In other words, instead of loading up on equities or bonds, it is about including investments that provide a buffer on the way down.

The jolly mood in financial markets started dissipating in August, though there wasn’t one single reason that triggered it. Rather it was a diverse set of market events and news that had the market players thinking twice about everything they had been investing in.

One of the highlights of the month was Moody’s downgrade of 10 small and midsize American banks on August 8^th quoting the higher funding costs, potential regulatory capital weaknesses and risks in the banks’ commercial real estate investments which have been weighing on bank balance sheets. Moody’s also placed six banking giants, including Bank of New York Mellon, US Bancorp, State Street and Trust Financial on review for potential downgrades. This news didn’t help the market sentiment given the previous series of bank failures earlier in the year.

One bright spot however was the much better than expected earnings reported by NVIDIA on August 23^rd which blew analyst estimates out of water. This triggered roughly a 1% spike in US equity index S&P 500 in couple of hours. Of course no market commentary could be considered complete without some form of news or update from the U.S. Federal Reserve (FED).

FED WILL FIGHT INFLATION TILL THE END

Even though the FED didn’t have an interest rate decision in August, the annual Jackson Hole Economic Symposium by the Federal Reserve Bank of Kansas City hosting the leading central bank heads had a similar influence on the markets. The conference that was held on August 24-26 in Wyoming dampened the market mood as some of the heavyweight central bankers, such as FED chair Jeremy Powell and the European Central Bank President Christine Lagarde underlined their goal to “beat inflation” and for that they will keep the interest rates as high and as long as necessary.

This came as no surprise to the bond markets which were already expecting not only the nominal rates but the inflation as well to remain elevated in the medium to long term. That said, the global government bond yields still saw a slight increase to better adjust for the “higher for longer” theme. As of August 25^th Bloomberg Global Aggregate Bond Index, the benchmark for global government bonds, was down by -0.8% on the month (bond yields and prices are inversely related; as yields go up, bond prices drop). Similarly Bloomberg Global Corporate Bond and High Yield Bond Indexes were also down on the month losing -1.2% and -0.85% respectively. This brought their year to date returns to 2.5% and 5.9% respectively.

MANY MARKETS SUFFERED FROM NEGATIVE MARKET SENTIMENT

Global stock markets as well as the leading crypto currencies and commodities suffered from the negative market sentiment despite some good economic news in the US and Europe that pointed to soft landing as opposed to a full blown recession. The European Union (EU) unemployment rate announced on August 1^st which was 6.4% (same as end of June) and the US unemployment rate of 3.5% (vs. 3.6% in July) announced on August4^th both pointed to relatively stable and healthy labour markets.

On the other hand, similar to July there were still some signs of softening in some of the larger economies such as US and Europe. Some economic indicators such as US existing home sales, US ISM non-manufacturing purchasing manager index (PMI) and EU Composite PMI came out lower than July, but again only marginally. While this data wasn’t as cheerful, the bigger concern for market players was the fact that the core inflation (CPI) which excludes energy and food prices still remained elevated. Indeed, the core CPI for EU came out at 5.5% (same as July) and that of US was 4.7% (vs. 4.8% in July).

The market reaction to the CPI data was relatively negative. As of August 25^th the US equity index S&P 500 and European stock index Euro Stoxx 50 were down by -4% and -5.3% for the month, dragging their year to date returns to 14.8% and 11.7% respectively. The global equity markets suffered from the negative sentiment as well with the global equity indicator MSCI All Country World Index (ACWI) and the emerging market index MSCI EEM both down by -4.9% and -7.3% on the month respectively.

GOLD AND CRUDE OIL FOLLOWED EQUITIES ON THE WAY DOWN

After a very strong July with over 14% return, crude oil reversed some of its gains on the back of a jittery market environment due to persistent inflation and slowing economic activity. As of August 25^th first month futures contract for US crude oil WTI was down by -2.4% bringing its year to date return back to flat on the year.

Gold also didn’t fare well in August. Over the same time frame the first month futures contract for Gold was down by -3.5% on the month, but managed to hang onto its gains from earlier in the year and delivered 6.2% return year to date. Gold prices have been partially buoyed by the strong global central bank demand for the precious metal since higher interest rates put a dent in the US Treasury returns.

CRYPTO MARKETS GAVE BACK SOME OF ITS GAINS

Similar to July, crypto markets continued to lose steam. As a result they continued to give back some of their earlier gains. As of August 25^th Bitcoin and Ethereum were both down by -11% on the month. While the cryptocurrency losses seem rather sizeable compared to equity and bond markets, this is expected given the higher risk and volatility in crypto currencies. As a result these negative returns are still small enough to make a dent in their year to date returns with Bitcoin still up 57.6% and Ethereum up 37.5% on the year.

TURKISH MARKETS SURPRISED ITS INVESTORS

Turkish stock market had another sizeable monthly return in August with 7% return in local currency terms (8.5% in US dollar basis) as of August 25^th. This brought the index’s year to date return to 40% in local terms while almost fully offsetting the market’s year to date loss and bringing it to-1.25% in US dollar basis. Part of the reason for the monthly performance in US dollar basis being higher than the one in local terms was due to 1.5% appreciation in Turkish Lira against the greenback, first time since the end of 2022. This was partially due to the rate hike from 17.% to 25% by the Turkish Central Bank on August 24^th. While it was below the market expectations, it provided some footing for the currency as well as the stock market in the last week of the month.

SAME DATA BUT DIFFERENT PERSPECTIVE

Looking at August, the curious thing wasn’t the fact that equities, crypto and commodities had reacted negatively to the relatively higher levels of inflation accompanied by somewhat soft economic data. It was the fact that the markets had responded to almost the same set of data with a totally opposite reaction in August vs July. In July those investors who had cheered over inflation which appeared to be restrained and economic data that pointed to a lower chance of recession seemed to be demoralized in August when faced with almost the same data. Why? Because they figured the macroeconomic data was not recovering fast enough and core inflation still remained relatively stable.

Clearly the data hadn’t changed. Then what did?

It was the market expectations and the interpretation of the data, particularly due to the realization that restrained inflation isn’t really sufficient for the central banks to cut rates or corporate profits to recover. As our readers may remember, in our previous issue we had explained the potential disconnect between slowing down inflation and corporate margins and how such an equity run like the one in July could fizzle out:

“Softer core inflation in July in many of the developed countries has revived hopes for central bank rate cuts in 2024. This could possibly support a bull run across assets for some time.. until it potentially runs into the disconnect between fast-falling inflation and potential squeeze on corporate margins and pressure on stock prices. Inflation falling is good news for sure. However, when accompanied by higher nominal interest rates and tight labour markets such as now, it means higher cost of capital and thus a drop in corporate margins and consequently in equity prices. Also, dropping inflation means lower prices on goods and services which just exacerbates the squeeze on corporate margins. “

WHAT SHOULD INVESTORS DO IN SUCH A MARKET ENVIRONMENT?

Hence, there is no new data that changed the market sentiment. Instead there is more insight gained by the market players collectively who have clued into the fact that slowing inflation is not sufficient for asset prices to revert upwards, be it equities, housing market, crypto or commodities. In fact, the market dynamics need to return fully back to normal particularly with lower inflation accompanied by lower interest rates so that asset prices can recover.

What can investors do in such a market environment? As we have reiterated in many of our previous issues, one of the golden rules of investment is to avoid putting all eggs in one basket. In other words, instead of loading up on equities or bonds, it is about including investments that provide a buffer on the way down. These include tools like indexes that increase when market volatility increase, global private market investments, trend following and other liquid alternative strategies accessible to retail investors. That way the ride for the portfolios would be much less bumpy in a market downturn than a traditional equity and bond portfolio. Therefore such protective investments are more additive in the long run and have a better chance of increasing in value.

Ela KARAHASANOGLU, MBA, CFA, CAIA

International Finance Expert

karahasanoglu@turcomoney.com

ela.karahasanoglu@ekrportfolioadvisory.com

https://www.linkedin.com/in/elakarahasanoglu/