August again proving a tricky month for stocks

A cocktail of weak Chinese economic data and a stronger-than-expected US retail sales number that drove the 10-year US treasury yield back over 4.2% led to a decline in stocks around the globe. An announcement from the Chinese authorities of another cut in interest rates only going to underline the continuing inability of the world’s second-largest economy to recover from its own Covid policies. This week the failure of one of China’s largest wealth managers, who is heavily exposed to the Chinese property market, failing to meet payments, adding to further concerns about the state of China’s real estate market.

 The correlation between the movement in treasuries and stocks continues, as does the movement between stocks and the USD. The dollar basket has gained over 3% in the past month as stocks struggle. The Vix, or fear gauge, has risen reflecting some reversal of sentiment but as the index remains well below its long-term average there may be room for it to rise further and stocks to weaken further. It also suggests at present no panic. Later today we get the minutes of the Federal Reserves July meeting as the debate turns away from how much further will US interest rates go up, but how long will they stay up here. It has not been a great month for any sector, healthcare has held up better than most, but rising bond yields have hurt the highly valued technology sector, in particular, this month. Commodity prices have taken a hit, even the oil price which had so far held up pretty well from strong demand and OPEC cuts has slipped back. Gold, sometimes a winner in periods of uncertainty, is now testing 1900 dollars an ounce as higher rates for longer make the yellow metal less appealing.

Mathew Klein in yesterday’s FT states that markets are pricing in the most benign of possible outcomes. The US economy will not go into a recession, this is definitely what equity is pricing in, inflation will continue to drift back to the 2% target and long-term interest rate expectations will start to fall. I think he refers to equity markets, and he is right, bond markets continue to paint a more cautious picture. The other point that should be made is equity markets have been driven higher by the expectation AI will drive the next leg of economic growth. As a result, prospective returns on stocks relative to bonds are lower than at any point since 2007. That we all know, it’s a point we have been making for a while. How will it resolve itself? If yields do start to fall that makes equities more attractive in theory, but not if it’s a response to weaker economic data.