Over the past two months, the mood has lifted across markets. As we expected, our companies rebounded strongly in July with a broadening out of macro-economic concerns and a second quarter results season which has shown that many parts of the global economy remain in robust shape.
Micro is what we do, macro is what we put up with, and this year has been all about macro. Macro can be as much a source of opportunity for long-term investors as volatility and market rotation. We believe that there are reasons for optimism and that there is much more to come.
Although the US economy entered a technical recession with its 0.9% second consecutive fall in quarterly GDP, this compared with Covid-recovery growth of 6.5% in the first half of 2021. After the strong market declines this year, investors appear to have been reassured by the US Federal Reserve’s policy of monetary tightening, interest rate increases and data-driven approach going forward, as if its determination to deliver a positive outcome was ever in doubt. As we write today, from the low point in mid-June, the S&P 500 index has risen 15% and the 10-year Treasury yield has fallen from 3.5% to c. 2.8%.
The outlook remains challenging and delivering a ‘Goldilocks’ economy, in which economic growth, inflation and interest rates are balanced, will not be straightforward. However, there are more positive indicators entering the frame. For example, core consumer price inflation (CPI) in the US in July was unchanged at 5.9% and has remained consistently below the peak of 6.5% in March. Inflation in services and wages is expected to persist in the coming months but energy and goods prices are already coming off.
Services account for 70% of the US economy and demand continues to be strong. As employment opportunities increase, savings rates decline and Covid relief checks are spent, labour supply should increase as people go back to work. Energy and goods prices have been impacted by the long-term lack of investment in production and transport capacity, Covid bottlenecks, in particular in China, and the Russia/Ukraine conflict.
Supply responses for energy and commodities will take time but a realignment of global supply chains and capacity increases are taking place. In the US, all-important gasoline prices are back to $4 per gallon in many places from over $5 in mid-June. The Russia/Ukraine conflict is a primary concern and looks likely to persist, but there are signs that some of its impact on the global economy will abate. Europe, and Germany in particular, is exposed to supply shortages and price increases in Russian gas but is working hard to replace it.
The upcoming winter heating period will be difficult but we believe that there are good reasons why Europe will get through it. To the extent Russia will want to maintain leverage on Europe, it cannot be interested in a complete replacement of supply and so it may be that intermittent reductions in supply are more likely than a complete shutdown. In commodities, the limited resumption of grain exports from Ukraine has to be taken as a sign of strategic engagement or leverage as well.
At the same time as European measures to replace energy sources and protect industries and consumers are put in place, price increases in the autumn should lower demand. The amounts involved in subsidising energy supply chains and consumers are staggering but in many ways just another example of government intervention after the global financial crisis and the Covid pandemic. Consumers may have to turn down their heating by a couple of degrees this winter and we have to realise that governments have no incentive to make positive statements at this point that would encourage people to increase not decrease their energy demand.