The extended stock market rally in developed markets dating back to the latter half of 2012 seemed to finally come to a screeching halt in July.  Increasing fears of deflation in the Eurozone were topped by a banking crisis in Portugal; this resulted in European equities being amongst the worst hit globally.  In addition, escalating wars in the Ukraine and in Israel, as well as a sovereign debt default by Argentina, contributed to the negative sentiment.  In contrast, a pick-up in China’s growth rate helped commodities-focused countries and contributed to a continuation in the rally in emerging markets after a difficult 2013.

The MSCI World was down -1.7% in July and is now up +3.2% YTD, with European shares down the most sharply on the month.  Interest rates poignantly highlighted the differences between the slow recovery in the Eurozone compared to the stronger growth in the US, with yields on 10-year German bunds collapsing another -7.2% on the month (and down -40.1% YTD to 1.16% from 1.93% at the beginning of the year) contrasting with US 10-year Treasuries remaining flat in July.  Energy and metal commodities both declined on general oversupply, though the fall comes after a rally earlier in the year.  Brent crude oil was down -5.6% for the month and is now down-4.3% YTD.  Gold fell -3.4% in July, cutting its gains for the year to +6.7% YTD.

South Africa passed a new credit act to tighten consumer-lending standards (lenders now need to demonstrate affordability of the debt) as well as to provide more protection for borrowers.  This comes after credit growth quickened again to +8.34% year-on-year in May, up from +8.27% in April (source).  In addition, the National Union of Metalworkers of South Africa and the Solidarity union signed a new wage agreement with mining companies, ending a month-long strike. The country has participated in the emerging market rally this year after a steep devaluation of the rand currency last year, and this momentum carried through into July.  The JSE All Share index was up +0.9% in July and +12.8% YTD.  The rand did weaken slightly against the US dollar by -0.7% in July and has now depreciated -2.0% YTD.

Further north, Nigeria is still struggling with the Boko Haram insurgency, with the rebels displacing more than 15 000 people with days-long raids (source).  The country has lagged behind other emerging markets so far this year.  The Nigeria All Share index was down -0.9% on the month and up +1.9% YTD.

In Asia, China’s economy grew at an annualised +7.5% in second quarter, faster than expected and the first time in three quarters that the economy has accelerated.  The economy had been slowing due to a central bank led clampdown on profligate lending, which resulted in a credit crunch.  China also scored a political win with an agreement by the BRICS countries (Brazil, Russia, India, China and South Africa) to set up a rival bank to the American and European dominated International Monetary Fund, to be based in Shanghai.  The country also eased tensions in the South China Sea by removing an oilrig deployed in disputed territorial waters.  The Shanghai Composite and Heng Seng indices surged +7.5% and +6.8%, respectively, in July and are now up +4.0% and +6.2%, respectively, for the year; the Shanghai index in particular may finally be breaking out of a long bear market since 2011 but still faces headwinds as the country transitions from an investment-led to a consumption-led economy.

In Southeast Asia, Indonesia elected Jakarta governor Joko Widodo as the country’s new president despite a lacklustre campaign.  Indonesia’s market has rallied in anticipation of the election result but fell towards the end of the month on investor concerns increased over whether the new president will be able to pass meaningful reforms through a legislature controlled by the opposition.  The Jakarta Composite was still up +4.3% on the month and is now up +19.11% for the year.

The halo around newly elected Indian Prime Minister Narendra Modi has started to fade, as the government’s first budget disappointed investors with a lack of crucial reforms.  India also failed to ratify the latest World Trade Organisation trade deal, agreed in Bali last December, which would simplify customs rules to potentially cut the cost of trade by 10 to 15% (source).  In addition, the country’s trade deficit worsened as gold imports surged.  However, the country’s power ministry did announce a plan to overhaul the sector in an effort to improve fuel supply and decrease the incidences of blackouts.  The BSE SENSEX index was still up +1.9% in July and is now up +22.3% YTD.

Russia’s backing of Ukrainian separatists in the eastern part of the latter country resulted in a civilian disaster when the rebels shot down a large airliner with Russian missiles, killing all on board.  Despite President Putin’s denials of Russia’s involvement in the Ukrainian conflict, most are adamant that Russia’s military is actively involved in the conflict.  As a result, the US and EU have started to apply much wider sanctions on Russia, particularly on the country’s ability to process financial transactions and raise external capital.  A court of arbitration in The Hague also ruled in favour of the former shareholders of Yukos to the tune of $50bn of damages, stating that the Russian government illegally expropriated the oil company’s assets.  The MICEX index was down -6.6% in July and is now down -8.2% YTD.

In Europe, Portugal’s Banco Espirito Santo’s financial problems compounded further as several affiliates filed for bankruptcy after the bank revealed that it had inadequate amounts of capital; the CEO also resigned after being arrested on tax fraud and money laundering charges.

In addition, there are growing fears of deflation in the Eurozone.  While the Purchasing Managers Index showed strong growth in the services sector, manufacturing fell to a seven-month low, with new orders and employment growth both remaining anaemic.  The inflation rate has now declined to +0.4% in July from +0.8% at the beginning of the year, substantially below the European Central Bank’s (ECB) +2.0% target.  The European Union at least has a head after appointing Jean Claude Juncker as the new president.  Spain also provided another glimmer of hope as the country’s economy grew +0.6% in the second quarter and added 190k jobs, the fastest pace in six years; the country is now expected to grow +1.3% this year.  Despite this, all major European markets were down on the month, with the French CAC 40, German DAX 30, Italian FTSE MID, and Spanish IBEX 35 down -4.0%, -4.3%, -3.3% and -2.0%, respectively, in July.  The CAC and DAX are now in negative territory YTD, down -1.2% and -1.5%, respectively.

The British government had its most extensive reshuffle since 2010; this is likely a sign of preparation for the next election in 2015 and means the government is unlikely to propose any new major legislation for the coming year.  The UK economy has recovered strongly after several years of quantitative easing by the Bank of England; the country’s GDP has now surpassed its pre-financial crisis high, and its central bank may be the first amongst major European countries to raise interest rates to contain inflation (this will likely be next year at the earliest).  The FTSE 100 index was only down -0.2% in July and is now down -0.3% YTD.

In the Americas, Brazil suffered a humiliating 7-1 home defeat to Germany in the World Cup, refocusing people’s attention on the large amount the government spent on hosting the event at the expense of delivering basic services to the public or supporting a slowing economy.  The country’s central bank had to ease bank reserve requirements in an effort to boost lending to support the economy despite a high inflation rate.  President Rousseff’s poll ratings are now at their lows for this term, making the presidential elections later this year an increasing competitive race.  Nevertheless, the Bovespa index recovered along with other emerging markets, up +5.0% in July and up +8.4% YTD.

Neighbour Argentina defaulted on its sovereign debts after a US federal court ruled that it was unable to pay creditors on current bonds unless it paid creditors on previously defaulted bonds dating from 2001.  The country was unable to come to an agreement with bondholders of the previously defaulted debts, causing Argentina to miss an interest payment.  Still, the country’s equity and bond markets have rallied in anticipation of a settlement, as many investors believe that the country will seek a compromise in order to access international capital markets again to lower the cost of borrowing and end capital controls.

After contracting by -2.1% in the first quarter, the US economy recovered impressively with +4.0% growth in the second quarter.  Still, Janet Yellen, Chairwoman of the Federal Reserve, reaffirmed the central bank’s commitment to continuing accommodative monetary policy due to the significant slack remaining in labour markets from unemployed workers who have dropped out of the workforce.  However, the Federal Reserve intends to end quantitative easing purchases by October, thus removing an active support that has buoyed equity and bond markets.  Yellen also spoke out warning of a stock market bubble, highlighting stretched social media and biotechnology stock valuations in particular.  The S&P 500 index retreated -1.5% in July but is still up +4.5% YTD.

As mentioned in recent months’ commentaries, equities in general have outpaced their underlying earnings growth, leading to fairly rich valuations, so the fall in developed market equities was expected at some point.  However, the ECB’s rate cut in June underwhelmed a market craving for more aggressive action to stimulate growth, and with inflation slowing in the Eurozone, the central bank is likely to have to take further action later this year to prevent the economy from stalling. Turmoil in the Middle East and Eastern Russia also adds to the list of things to worry about.  Still, the secular bull market in equities may continue (albeit with more volatility) due to the substantial liquidity in markets from quantitative easing and improving economic prospects in China, India, Japan, the UK and the US.  The enthusiasm across financial markets is apparent given the robustness of the equity markets to broadly retain value as whole during a month marked with numerous negative news.

Sources: RisCura, Bloomberg, CNBC, Economist, Fin24, Financial Times, MarketWatch, Reuters.

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