Denis Sagaert’s monthly market highlights - July '23

Equity markets: Global losses due to Fed’s hawkish statements World equities declined by 1.7% in euro and 3.5% in local currencies. The main market driver was the FOMC meeting on September 19-20. As expected, the Fed did not raise its Fed Funds target range. However, Fed chairman Jerome Powell delivered a rather hawkish speech. He insisted on inflation remaining elevated, while the US economy still grows at a healthy pace. As a result, one final hike is expected before year end, but the pace of monetary easing should be slow in 2024. The latest US CPI , published on September 13, did not justify a softer tone by the US central bank. The CPI rose from 3.2% to 3.7% in August. Core inflation (ex Food & Energy) declined from 4.7% to 4.3%, but both indices are still well above the 2% official objective. The higher for longer interest rates outlook had a negative impact on US equities , which dropped a lot more than European and emerging market equities . Unlike other sectors , energy was up as WTI crude rose (+9%) above 90 USD/bbl. Bond markets: US Treasury Bonds yield reaches its peak since 2007 Jerome Powell’s message pushed bond yields higher. The yield on 10-year US Treasury Bonds surged from 4.11% to 4.57%, a level last observed in 2007. The yield on 10-year Bunds rose from 2.47% to 2.84%. September was therefore not a good month for bond markets . The Bloomberg Global Aggregate EUR-Hedged Index, representing the global investment grade universe, was down 1.9%. Corporate bonds declined less than sovereign bonds. High yield corporate bonds outperformed. The average for Euro-denominated bonds was even slightly positive. Currencies: gold and EUR/USD rate impacted by high interest rates Suffering from higher interest rates, gold fell by 4.7% in USD. The US dollar strengthened on the back of the Fed’s hawkish tone. It gained 2.6% vs the euro , thereby reducing losses on US assets for eurozone investors.

Equity markets: volatility is back World equities were weaker in August (-1.3% in euro and -2.1% in local currencies). The Fed’s monetary policy remained at the heart of investors’ concerns. During the first half of the month, sentiment deteriorated on fears of more tightening, and equities dropped by about 5%. As the outlook then turned into a more dovish scenario, equities rebounded and almost erased their losses. Jerome Powell delivered a highly anticipated speech at the Jackson Hole annual central banker gathering but did not move the markets. He simply confirmed the Fed’s inflation target (2%) while taking into account a range of economic indicators. Analysts generally expect no hike at the next meeting (September 20) and a final hike (+25 bps) at the following meeting (November 1). The Federal Reserve has no particular reason to worry about the economy. The US GDP rose by 2.2% during the second quarter. Inflation is moving in the right direction but remains too elevated to cut rates. The US CPI rose by 3.2% in July and the Core CPI (ex Food & Energy) was up 4.7% over 12 months. Eurozone economic indicators are weaker. Second quarter GDP growth was only +0.6% and inflation is higher than in the US. Core inflation (5.5%) is sticky. Emerging markets underperformed, mostly due to China. The People’s Bank of China cut rates for the second time as economic indicators deteriorated. Mid and small cap stocks fell more than large caps. Sector dispersion was limited. Energy and healthcare outperformed. Bond markets: long-term rates approaching peak Bond markets were relatively quiet. Long term rates rose modestly. The yield on 10-year T-bonds went from 3.96% to 4.11%. 2-year yields in USD and EUR declined marginally. The Bloomberg Global Aggregate EUR-Hedged Index, representing the global investment grade bond universe, was down 0.3%. Corporate high yield bond indices rose modestly. 3-month treasury bills currently offer a higher yield than 2-year bonds, as the Fed and the ECB are expected to cut rates in 2024 and 2025. Currencies and commodities: euro weakens in comparison to the dollar The euro depreciated vs. the dollar (-1.4%) but gained 3.5% vs. the NOK. Gold declined by 1.3% in USD (stable in EUR). Crude oil rose by 2% (83.6 USD/bbl at month end).

Equity markets: rebound led by the technology sector World equities performed very well in June and closed the first semester on a significant gain of 11.5% in euro and 14% in local currencies. Sector dispersion was wide. In the United States, three sectors stood out: IT, consumer discretionary and communication services . More specifically, a large part of the positive performance came from 7 stocks: Nvidia, Apple and Microsoft (IT), Tesla and Amazon.com (consumer discretionary), Alphabet and Meta Platforms (communication services). This was partly due to expectations on artificial intelligence, or even entirely in the case of chip maker Nvidia (+190%). In addition, the macro environment improved for growth equities. Their poor performance in 2022 was due to surging long-term interest rates, rather than poor earnings. As inflation is decelerating, long term rates have stabilized in H1 2023, triggering a recovery in tech stocks. Those 7 mega cap companies now represent more than 27% of the S&P 500 Index. Their impact is clear when comparing the performance of the S&P 500 Index (+16.6%) with the average performance of each index component (+7%). For the vast majority of listed US companies, the first half of the year was positive but not exceptional. In this context, the Nasdaq 100 surged by 39%. Eurozone equities also performed very well. The Eurostoxx 500 gained 18.4%, with large contributions from technology companies (ASML Holding, Infineon and SAP) and consumer giants (LVMH, L’Oréal, Hermès). Small and mid-cap equities went up but underperformed large caps. “Value” and “High Dividend” investment styles did not participate to the rally. They contain a larger proportion of banks, consumer staples, energy, healthcare, and real estate. The Emerging Markets index only rose by +2.6% in euro and clearly underperformed developed markets, due to the Chinese market. Foreign investor confidence is still low, by fear of government interventionism and political tensions with the US. Bond markets: slight increase in yields compared with 2022 After rising significantly in 2022, bond yields only went up moderately in H1 2023. 10-year Bund yield went from 2.28% to 2.39%. US 10-year Treasury bond yield closed the semester at 3.84% against 3.64% at the end of 2022. Considering the income, sovereign and investment grade corporate bond indices posted a positive performance in 2023. High yield had a stronger performance, gaining more than 4% in euro. Central banks: the fight against inflation continues The main central banks tightened their monetary policy to fight inflation. The Federal Reserve raised its Fed funds rate from 4.25-4.50% to 5-5.25%. The European Central Bank raised its deposit facility rate from 2% to 3.5%, the highest level since 2001. USD and EUR yield curves are clearly inverted. Despite higher short-term rates, the US and Eurozone economies are not in recession and US unemployment is historically low (3.5%). As a result, analysts believe that short-term rates have peaked and may go down in late 2023 or at least in the spring of 2024. Currencies and commodities: appreciation of the euro and fall in European gas prices The euro appreciated vs. the dollar (+1.9%) and was much stronger vs. the yen (+12.1%), the Norwegian kroner (+11.6%) and the yuan. The first semester was uneventful for gold , which rose by 5.2% in USD. Energy and base metal prices declined. Conclusion Stock market performance in 2022 and H1 2023 demonstrates the difficulty of market timing and shows that tactical allocation should not only be based on recent performance. However, one can compare valuations between asset classes. The 2024 P/E ratio for the S&P 500 is 18.4, which is quite high, while bond yields are back to acceptable levels. Corporate investment grade bond yields in USD are close to 5.5%. Even though equities have the highest long-term expected return, their advantage is not as high as it used to be. For investors with a medium-term horizon, bonds offer an interesting alternative. In addition, the stock market rally has been narrow. The Nasdaq 100 trades at almost 25 x expected 2024 earnings, including much higher multiples for Tesla, Nvidia, Amazon.com and even Microsoft. One has seen in the past that very high valuations for market leaders rarely leads to attractive long-term performance. Of course, even for companies that seem overvalued, valuations can remain sky high for a long time and timing is difficult. At the opposite, small and mid-cap stocks trade at less than 15 x expected earnings for 2024 and offer a much better safety margin. They continue to represent a good portion in our managed portfolios.