Summary
Bonds more attractive as recession looms
US treasury bonds are coming back in from the cold after a terrible six months of performance when they gave little protection from plunging markets. Bonds are seeing renewed interest again as recession growth risks rise and inflation forecasts fall, with bond yields risen sharply. Long term bonds, like the IEF and TLT exchange traded bond funds, are the most sensitive to this. Short term bond funds, like BIL and SHY, more defensive. The bond market is clearly signalling that recession is increasingly likely.
Inflation and earnings headwinds
Markets hurt by a new US inflation high, risk of a next 1% Fed rate hike, and US banks weak Q2 earnings start. China was hit by renewed covid and reg-tech concerns, and Europe by gas supply and Italian political uncertainty. This week to see historic ECB rate lift-off. We see only a gradual U shaped recovery.See latest presentation, video updates, and twitter @laidler_ben.
Race between recession and inflation
High 9.1% US and 8.6% EU inflation is driving hawkish central banks, and recession risks. A second half 2022 inflation decline, and Christmas end to rate hikes, is market catalyst.
‘Our currency, your problem’
US dollar soared 20% the past year, a two decade high vs major currencies, cutting US earnings growth and tightening global conditions. Its 45% of all FX trading vs 25% world GDP.
Europe’s energy nightmare deepens
Europe and UK natgas prices surged again, the region’s worst energy fear, as Nord stream closes. Stokes inflation and recession risks. See @OilWorldWide, @EuropeEconomy.
Euro is still not cheap
EUR/USD parity biggest line-in-the-sand level in global FX markets. EUR fundamentals are worsening and valuation not cheap.
Crypto assets resilient to inflation spike
Bitcoin (BTC) was resilient to latest US inflation surprise, whilst Polygon (MATIC) was boosted by latest in string of adoption announcements, and Uniswap (UNI) by its Robinhood (HOOD) platform listing. DOGE held back by Elon Musk backing away from Twitter (TWTR) deal.
Recession worries hurt commodities
Commodity markets fell further as recession worries intensified as US yield curve ‘inverted’ and dollar surged to a 20-year high. This drove a 10% fall in ‘Dr. Copper’, whilst wheat prices also slumped on the hope that Ukraine could resume stalled exports. US gasoline prices fell from $5/gallon highs, easing inflation fear.
The week ahead: earnings season accelerates
1) Q2 earnings accelerate after weak start with banks BAML, GS, tech NFLX, TSLA, healthcare JNJ, ABT. 2) ECB to raise interest rates for first time since 2011 and to announce bond plan. 3) Flash PMIs from US, EU, UK, Japan a timely health check on growth and inflation risks.
Our key views: Inflation versus recession race
Recession and earnings risk driving markets, with valuations slumped and bond yields peaked. Recession not inevitable, on resilient corporates and consumer, and easing price pressure. But recovery only U-shaped. Focus defensives, in ‘new’ world and to manage risks. Healthcare and high dividend yield, to UK and China.
Top Index Performance
| 1 Week | 1 Month | YTD | |
| DJ30 | -0.16% | 4.68% | -13.90% |
| SPX500 | -0.93% | 5.12% | -18.95% |
| NASDAQ | -1.57% | 6.06% | -26.80% |
| UK100 | -0.52% | 2.03% | -3.05% |
| GER30 | -1.16% | -1.99% | -19.01% |
| JPN225 | 1.02% | 3.18% | -6.96% |
| HKG50 | -6.57% | -3.69% | -13.25% |
*Data accurate as of 18/07/2022
Market Views
Inflation and earnings headwinds
- Markets buffeted by stiff bad news headwinds. US inflation rose to a new high, driving potential for a coming 100bps Fed rate hike, and US banks led a weak Q2 earnings season start. Also, China was hit by renewed covid and reg-tech concerns, and Europe by gas supply and Italian political uncertainty. This week see ECB rate lift-off. We see only a gradual U-shaped recovery. Page 6 for Resource reports, presentations, videos, twitter.
Race between recession and inflation
- High US and EU inflation driving hawkish central banks. They were late to the inflation threat and now hiking into a growth slowdown. The longer this goes, the more likely recession. Consumer and corporate buffers are not insurmountable.
- June’s 9.1% US inflation surprise makes a 100bps July 27th rate hike very possible. A second half 2022 inflation decline, and Christmas end to rate hikes, is the market catalyst. Until then it’s a bear market rally, and U-shaped recovery.
‘Our currency, your problem’
- US dollar soared 20% the past year, a two decade high vs major currencies. It has negative impacts, from tightening financial conditions to exporting high inflation. As a US Treasury Secretary said ‘the dollar is our currency, but it’s your problem’.
- But this is not a one-way street. The stronger dollar is also holding back US corporate earnings growth, whilst giving a welcome competitiveness boost to many European and Asian exporters.
- The US dollar dominates global financial system, making up around 65% of international debt, 60% of global currency reserves, and 45% of all currency trading. This is dramatically larger than the US’s one quarter weight in the global economy. It is also around three times the usage of its nearest currency competitor, the Euro.
Europe’s energy nightmare deepens
- Europe and UK natgas prices have surged again, the region’s worst energy fear. Is stoking inflation and recession risks. Immediate cause is closure of Nord stream pipeline and fear it may not reopen.
- The focus remains on trying to fill gas storage before the winter demand spike. This price surge has left US gas and global oil prices in the dust, a stark reminder of the local nature of gas markets. @OilWorldWide, @EuropeEconomy.
The Euro is still not cheap
- EUR/USD parity is the biggest line-in-the-sand level in global FX markets. It has not been breached in twenty years. But the odds are increasingly stacked against the EUR, with its deteriorating relative fundamentals, as the energy crisis worsens, and still far from ‘cheap’ valuation, especially vs the JPY.
- A fall below 1.00 stoke’ Europe’s imported inflation concern, but is not be all bad news. It would be ‘growth insurance’ for many big exporters, from Airbus (AIR.PA) to ASML (ASML). Over 50% of European corporate sales come from abroad, versus only 30% for US companies.
Key events to watch in third quarter 2022
Crypto resilient to latest inflation high
- Bitcoin (BTC) held around $20,000, despite the latest high US inflation surprise, and increase in Fed rate hike expectations. Weakness led by Dogecoin (DOGE), dampened by Elon Musk backing away from his Twitter (TWTR) takeover.
- Strength was led by Polygon (MATIC), after it was the only blockchain selected to be part of Disney’s 2022 Accelerator Program, the latest in a string of major adoption announcements. Also decentralised trading protocol Uniswap (UNI), as was listed on the Robinhood (HOOD) platform.
- Bitcoin addresses rose to 1.0 billion for first time, as adoption continues. Lender Celsius Network filed for bankruptcy, after halting withdrawals.
From commodity feast to famine
- Commodities eased further on recession worries and a surging US dollar. Is now worst performing asset class this month and back at pre-Ukraine invasion levels, a turnaround from leadership so far this year. This helped cut medium term US inflation expectations by 0.2% in the past month.
- ‘Dt. Copper’ fell 10% as US yield curve ‘inverted’, with short term yields above long term, in one of the clearest market signs of a coming recession. Meanwhile US gasoline prices fell from a record $5/g, as high prices cooled consumer demand.
- Wheat prices also fell 10% on hopes for a deal to resume Ukraine’s stalled wheat exports.
US Equity Sectors, Themes, Crypto assets
| 1 Week | 1 Month | YTD | |
| IT | -1.50% | 7.31% | -27.30% |
| Healthcare | -0.66% | 9.98% | -10.09% |
| C Cyclicals | -0.60% | 8.09% | -29.13% |
| Small Caps | -1.41% | 5.73% | -22.31% |
| Value | -0.55% | 3.33% | -12.99% |
| Bitcoin | -3.20% | 0.80% | -55.55% |
| Ethereum | 1.98% | -14.64% | -66.25% |
Source: Refinitiv, MSCI, FTSE Russell
The week ahead: earnings season accelerates
- Q2 earnings accelerate with banks BAML to GS, tech titans NFLX, TSLA, ASML and healthcare heavyweights JNJ, ABT. Company profits been a key market support. Forecast is +5% S&P 500 growth, 20% in EU, and 30% UK.
- The ECB (Thu) to raise interest rates off zero to 0.25%, or more, in first rise since 2011. Face cross-currents of 8.6% inflation, 4x target, but soaring recession risk on energy crisis. Also see plan to contain diverging gov. bond yields.
- Flash US, EU, UK, Japan July PMI’s (Fri) give a timely outlook for pace of the global economic slowdown and inflation risks. Numbers have fallen towards the breakeven 50 levels below which signifies an economic contraction.
- Hope EU gas imports restart on Nord stream pipeline (Thu) after maintenance shutdown.
Our key views: Recession fears in driving seat
- Saw biggest sell-off since the 2020 covid crash. Recession and earnings risk drive markets, with valuations slumped and bond yield peaked. See the fundamentals stressed but secure, with recession not inevitable, on resilient corporates and consumer. But recovery U, not V, shaped.
- Focus on cheap and defensive assets. To be invested in this ‘new’ world, but to manage still very high risks. See Value sectors, like healthcare, defensive styles like high dividend yield, and related markets from UK to China.
Fixed Income, Commodities, Currencies
| 1 Week | 1 Month | YTD | |
| Commod* | -2.11% | -10.51% | 14.42% |
| Brent Oil | -5.62% | -10.98% | 29.75% |
| Gold Spot | -1.98% | -7.34% | -6.77% |
| DXY USD | 0.91% | 3.14% | 12.52% |
| EUR/USD | -1.04% | -3.95% | -11.35% |
| US 10Yr Yld | -16.51% | -31.71% | 150.53% |
| VIX Vol. | -1.66% | -22.17% | 40.71% |
Source: Refinitiv. * Broad based Bloomberg commodity index
Focus of Week: Bonds back in the investor toolkit
Bonds are coming back in from the cold after a terrible six months of performance
Fixed income, and especially US government bonds, had one of its worst six months in memory. It endured a perfect storm of rising interest rates, inflation, and high initial valuations. This was a shock to usually some of the world’s safest investments, backed by the full faith and credit of the world’s largest economy, and dominant currency. They are the key building blocks of global finance and amongst the widest held instruments. But with yields now higher, and inflation expectations falling, they are more attractive again.
Fixed income has provided no protection from plunging markets
With its income fixed, the sensitivity to inflation is high. The longer the bonds term, or duration, the more sensitive it is to being eroded by inflation. It has been a tough year. With low bond yields at the start of the year (yields move inversely to bond prices). Further sharp rises in inflation concerns. And a US Fed turning more aggressive raising rates. This bond slump has been most dramatic for longer data bonds (see chart). It has also seen a volatility surge. The MOVE index (bond equivalent of VIX equity vol index) has doubled.
But bonds are now starting to become ‘investable’ again as inflation expectations fall
Bond yields have now risen significantly to above inflation expectations, giving a positive ‘real’ yield. Additionally, with the Fed aggressively raising interest rates and recession fears mounting, inflation expectations are now showing signs of peaking. Five year forward US inflation expectations have fallen from a peak of 2.7% to a current 2.1%. Whilst 10-year bond yields have eased back from 3.5% to 3.0%. This is beginning to attract some investor inflows back into bonds, after the dramatic price rout this year.
Long term bonds the most sensitive to inflation; short term the most defensive
The longest-term bonds, most sensitive to inflation, are 20+ year US Treasuries (in TLT ETF). They are down over 33% from 2020 highs. Next most sensitive are 7–10-year US Treasury bonds in IEF ETF. More defensive are the shorter term 1-3 year bonds in SHY ETF. Most defensive are shortest duration 1-3 month BIL ETF.
The bond market is also telling worrying messages on a coming recession
The bond market is also telling us worrying signs on potential recession. The yield curve has near ‘inverted’, with short term yields above long term. This is historically a strong indicator of a coming recession.
US Treasury Bond ETF Performance vs Inflation (Last 5 Years)
Key Views
| The eToro Market Strategy View | |
| Global Overview | Geopolitical risks alongside the Fed hiking cycle is boosting uncertainty and weakening markets. We see this as slowly fading, the global growth outlook secure, and valuations more compelling. Focus on cheap cyclical and defensive assets within equities, like Value, plus commodities, crypto. Relative caution on fixed income and the USD. |
| Traffic lights* | Equity Market Outlook |
| United States | World’s largest equity market (60% of total) seeing strong c4% GDP growth and resilient earnings growth outlook. Valuations have now fallen back to average levels, and are supported by peaked bond yields and high company profitability. Fed interest rate risks are now well-priced. See cyclicals and value catch-up, after lagging for a decade, whilst big-tech supported by structural growth outlook. See overseas markets leading in global ‘U-shaped’ rebound. |
| Europe & UK | Favour defensive and cheap UK equities (‘Economies are not stock-markets’) over high risk/high return continental Europe. Recession risks rising with Russia and energy crisis, threatening to overwhelm ‘buffers’ of rising fiscal spending (defence and refugees), low interest rates (slow to raise ECB), and weak Euro (50%+ sales from overseas). Equities cushioned by greater weight of cheap cyclical sectors, lack of tech, and 25% cheaper valuations versus US. |
| Emerging Markets (EM) | China, Korea, Taiwan dominate EM (60% wt), and more tech-centric than US. Positive on China as economy reopens, cuts interest rates, and eases tech regulation crackdown. Valuations 40% cheaper than US and market out of favour. Recovery helps global sectors from luxury to materials. More cautious rest of EM on rising rates and strong USD. |
| Other International (JP, AUS, CN) | Canada and Australia benefit from strong equity market weight in commodities and financials, as global growth rebounds and bond yields set to rise. Japanese equities among cheapest of any major market and vaccination rates accelerating, but has structural headwinds of low GDP growth, an ageing population, and world’s highest debt. |
| Traffic lights* | Equity Sector & Themes Outlook |
| Tech | ‘Tech’ sectors of IT, communications, parts of consumer discretionary (Amazon, Tesla), dominate US and China. Expect more subdued performance as bond yields rise. But are structural stories with good growth, high margins, fortress balance sheets that justify high valuations. ‘Big-tech’ the new defensives. ‘Disruptive’ tech more vulnerable. |
| Defensives | Core positions as macro risks rise and bond yields are better priced. Consumer staples, utilities, real estate attractive defensive cash flows, less exposed to rising economic growth risks, and robust dividends. Offset impact of higher bond yields. Healthcare most attractive, with cheaper valuations, more growth, some rising cost protection. |
| Cyclicals | Cyclical sectors, like consumer discretionary (autos, apparel, restaurants), industrials, energy, and materials, are cheap and attractive in a ‘slowdown not recession’ scenario. Are sensitive to re-opening economies, resilient GDP growth, and higher bond yields, with depressed earnings, cheaper valuations, and have been out-of-favour for many years. |
| Financials | Benefits from higher bond yields, charging more for loans than pay for deposits. Also one of cheapest P/E valuations, and room for large dividend and buyback yields. But is being outweighed by rising recession risks, with lower loan demand and higher defaults. Banks most exposed. Insurance and Diversifieds (like Berkshire Hathaway) least. |
| Themes | We favour Value over Growth on GDP resilience, lower valuations, rising bond yields, under-ownership after decade under-performance. Dividends and buybacks recovering with cash flows. Power of dividends under-estimated, at up to 1/2 of total long term return. Secular growth of Renewables and Disruptive Tech themes. |
| Traffic lights* | Other Assets |
| Currencies | USD well-supported for now by rising Fed interest rate outlook and ‘safer-haven’ bid on virus fourth wave virus. This is likely more modest than prior USD rallies as rest of world growth recovers and virus fears ease. A strong USD traditionally hurts EM, commodities, US foreign earners, such as tech, but helps EU and Japan exporters. |
| Fixed Income | US 10-year bond yields to rise modestly as inflation above 2% average Fed target, ‘real’ inflation-adjusted yields negative, Fed to gradually tighten policy. Will be modest as inflation expectations already high, wide spread to other market bond yields, and structural headwinds of all-time high debt, poor demographics, and low productivity. |
| Commodities | In ‘sweet spot’ of robust GDP growth, ‘green’ industry demand, years of supply under-investment, recovering China, and Russia supply crisis. Industrial metals and battery materials well positioned. Oil helped by slow return of OPEC+ supply and Russia 10% world supply problems. Gold helped by risk-aversion but held back by rising bond yields. |
| Crypto | Institutionalization of bitcoin market barely begun, as asset class benefits from very strong risk-adjusted returns and low correlations with other assets. Altcoins have outperformed as see broader interest and use cases. Clear supply rules a benefit as inflation rises. Volatility remains very high, with the 16th -50% pullback of the last decade. |
| *Methodology: | Our guide to where we see better risk-adjusted outlook. Not investment advice. |
| Positive | Overall positive view, and expected to outperform the asset class on a 12-month view. |
| Neutral | Overall neutral view, with elements of strength and weakness on a 12-month view |
| Cautious | Overall cautious view, and expected to underperform the asset class on a 12-month view |
Source: eToro
Analyst Team
| Global Analyst Team | |
| CIO | Gil Shapira |
| Global Markets Strategist | Ben Laidler |
| United States | Callie Cox |
| United Kingdom | Adam Vettese Mark Crouch Simon Peters |
| France | Antoine Fraysse Soulier David Derhy |
| Holland | Jean-Paul van Oudheusden |
| Italy | Gabriel Dabach |
| Iberia/LatAm | Javier Molina |
| Poland | Pawel Majtkowski |
| Romania | Bogdan Maioreanu |
| Asia | Nemo Qin Marco Ma |
| Australia | Josh Gilbert |
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