Developed Markets Rebound
In July, international developed stock markets returned 4.97%. The US and Japan recorded returns of 9.29% and 5.70%, respectively. The UK and Pacific ex Japan lagged other markets. International developed markets are down -14.72% YTD, while the US market is down -13.97%. Geopolitical risks, persistently high inflation, and central bank tightening continue to be headwinds. Investors are expecting the Federal Reserve to reduce its holdings of Treasury bonds and mortgage-backed securities, which could cause long-term interest rates to increase. A rising rate environment could negatively impact stocks with long durations, such as growth stocks.
Emerging Markets Flat
Broader emerging markets posted a -0.83% return for the month. India and Korea recorded positive returns of 9.32% and 5.81%, respectively. Mexico and China lagged other markets in July. Countries that export natural resources, such as Brazil, have benefited from this year’s inflationary environment. High energy and food prices have been headwinds to emerging market economies. China’s zero-Covid policy has also been a drag on economic activity.
Information Technology and Consumer Discretionary Outperform
In July, information technology and consumer discretionary recorded positive returns of 12.70% and 12.84%, respectively. Year to date, these sectors are still in bear market territory. Telecommunications and healthcare lagged other sectors this month. The energy sector is up 33.2% YTD and 51% over the past year. Oil supply and demand dynamics will likely remain favorable in the short and medium term.
DOMESTIC EQUITY FACTORS
Growth Rallies in July
In July, value underperformed growth in the large- and small-cap space. Momentum recorded a return of 11.67%. Value stocks are still outperforming growth in 2022. Their ten-year annualized returns are approaching growth’s ten-year return. Even after value’s strong performance, value stocks are still cheap relative to growth stocks. Value-oriented sectors such as energy, financials, and materials may still have much more room to run.
FOREIGN EQUITY FACTORS
Value Underperforms in the International Markets
Value underperformed growth in the large-cap and small-cap space for the month in the international developed markets. Momentum recorded a return of 3.11%, while small-cap emerging market stocks posted a return of 1.76%. Valuations of value stocks are still very low relative to growth stocks in both international developed and emerging markets, which is consistent with the US market. The rotation from growth into value may resume as investors become wary of high valuations in growth stocks. Rising interest rates may also pose more risk to growth stocks than value stocks.
Short-Term Interest Rates Rise
In July, the three-month Treasury bill index returned 0.05%. From the beginning of the year through the end of July, the interest rate on the 90-day Treasury bill increased from 0.08% to 2.41%. Savers are now getting paid much more in interest; however, they will still face low real interest rates if inflation remains high. The CPI has increased by 9% over the past year through June.
DISINFLATION DEFLATIONARY HEDGES
Fixed Income Investments Rebound
The returns of deflationary hedges were mainly positive for the month. Long-term municipal bonds returned 3.77% in July. The Bloomberg Barclays US Agg Bond Index returned 2.44% for the month. High-yield bonds are down -8.86% YTD. If interest rates continue to rise, less creditworthy borrowers may face difficulties meeting their financial obligations. Among the deflationary hedges, only the SwissRe Global Catastrophe Bond index has a positive performance YTD. Catastrophe bonds are up 2.61% over the past year, providing a competitive yield without the equity-like volatility of leveraged loans and high-yield bonds. Real yields continue to remain around historical lows.
INFLATION SENSITIVE INVESTMENTS
Commodity Markets Providing Diversification Benefits
Inflation-sensitive investment returns were mainly positive for the month. US natural gas and the Alerian MLP were up 52.87% and 12.49%, respectively. The Bloomberg Commodity index posted a return of 4.26% in July. Gold bullion is down -2.90% YTD. This year, the US dollar has materially strengthened, moderating gold’s return in US dollar terms. However, gold bullion is up much more relative to other major currencies. Like oil’s future supply prospects, the future supply of gold may be constrained as exploration and capital expenditures have been muted.
U.S. Dollar Strengthens Versus Other Currencies
Over the past three months, the U.S. dollar appreciated against most major currencies except the Swiss Franc and Mexican Peso. However, the continuation of large US fiscal deficits may weigh on the US dollar in the medium-term to long-term. Gross federal debt to GDP stands at 123% and is forecasted to increase through the decade.
Brandon Yee, CFA, CAIA – Research Analyst
Brandon conducts investment due diligence for Versant Capital Management, and designs and implements tools and processes to support the firm’s research. His background in biology and finance help him to look at challenges from multiple angles, resulting in unique and well-rounded approaches and solutions.
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