Monthly Commentary | July 22

Bond markets are currently the driving force behind much of what is happening in broader financial markets.  During July, bond markets globally reasoned that economic growth was now more challenged than previously expected, and therefore pulled back expectations around how far central banks will hike rates.  This resulted in a large rally in bonds with values increasing by 2-3% over the month (though this still leaves the markets negative for the year to date and over 12 months). 

Perhaps counterintuitively this acknowledgement by markets of a weaker economic outlook didn’t result in equities falling, but rather they too rallied – simply because of the relationship between bond yields and equity valuations (i.e. as bond yields fall the value the market places on expected dividend cashflows and discounted future equity valuations increase). 

The interesting next stage for equities is the extent to which economic weakness and reduced consumption (due to inflation) will result in lower earnings, lower dividends and lower capital growth.  Clearly these factors will result in equity valuation weakness, but only to the extent that they are worse than what is currently expected, and for now equity valuations as a whole are being more influenced by interest rates than underlying fundamental company data.  This should allow for a good stock picking environment.