The month of July was positive for global equities as we saw an increase of more than 10% in the MSCI World Index (EUR). And it is that since the lows seen in mid-June, the stock markets have begun a continuous rise. In Europe, the Stoxx 600 posted a rise of 7% last month and our Ibex 35 lagged behind with a timid rise of 0.71%.
In general terms, a large part of the sectors managed to post positive returns and especially of the technology and consumer discretionary companies, linked to economic growth, the most important returns. It has happened to the selective Spanish that it is overrepresented in the energy, finance and communications services sectors that remained practically flat.
Central banks marked the pulse last month. The Federal Reserve raised rates by 75 basis points, however Chairman Jerome Powell later commented that the pace of policy tightening could slow from that move. On the part of the ECB, it raised the price of money by 50 basis points more than expected, putting an end to the era of negative rates. The ECB also unveiled its new “anti-fragmentation tool” which is designed to prevent risk premiums from peripheral countries, especially Italy, from jumping.
Usually, what the markets are evaluating positively is that inflation is being attacked, even if this means heading towards a recession. In fact, as we discussed recently, the United States has already entered a technical recession.
Watch Out for Stock Outlooks: The Importance of Margins
This rise experienced may be a mirage. If central banks manage to control inflation, we are headed for recession. Or purchasing power is lost due to rising prices or the contraction of the economy. The question is to choose what should be the lesser evil. If we go into a recession, the current market expectations deteriorate further due to the expected discount in flows, which would not lead to lower prices.
In a high inflation environment, revenue growth is not hard to come by. Prices are rising everywhere, and businesses and consumers are in for a surprise. Companies can grow their top lines simply by raising their priceswithout the need to sell more units.
But the costs of inputs (raw materials, transportation, wages, and the list goes on) are also rising.. The highest quality companies are the ones that can increase their selling prices faster than the suppliers increase theirs. That is the definition of pricing power.
Thus, we have clear risks to corporate profit margins arising from a worsening of the macroeconomic outlook and an increase in costs. Central banks appear intent on reining in inflation by suppressing growth, raising the risk that a post-corona restart will be derailed.
And the margins have started from a somewhat utopian situation. Revenue growth has been unprecedented since Covid-19. Companies have also reported unprecedented pricing power in the past two years amid supply disruptions. So the combination of government stimulus and supply chain disruptions from forced shutdowns has fueled this bull cycle at the margins.
profit growth held firm in the first quarter of the year in the face of higher inflation, higher interest rates and a potential “hard landing,” as year-over-year profits and revenues grew 42.1% and 22.9%, respectively.
If we look at the prospects for the coming quarters, the first drop in profits would be seen in the first quarter of the following year (-5.3%) and in the second we would see a joint drop in income (-4.4%) and profits (-6.2%). Recession risks are rising as liquidity tightens and household confidence plummets.
Put a stop to inflation
Central banks are taking coordinated action to kill inflation. This response involves attacking demand and its expectations, which leads us into the shadow of the recession. Hence, oil prices have contracted and the barrel of Brent is trading below the psychological barrier of 100 dollars.
We have already seen how Oil prices have fallen 28% from their recent closing high of $123.70 on March 8 after the Russian invasion of Ukraine.
Crude rises reversed after a rebound in the first five months of the year, extending this month’s losses after losses in June and July. The sell-off wiped out gains from Russia’s invasion of Ukraine, which would ease inflationary pressures in the global economy that have prompted central banks, including the Federal Reserve, to raise interest rates.
The play is going well: demand cools. For example, in the United States, the energy body EIA has pointed out that Americans are using less gasoline than last summer (when prices were lower), but even during the summer of 2022, when covid-19 still restricted the trips.
On the supply side, the Organization of the Petroleum Exporting Countries and its allies, including Russia, agreed to a small increase in the collective offer for September, while warning that their available capacity was extremely limited. Saudi Arabia, the de facto leader of the group, has pushed oil prices to record highs for Asian buyers.
From a European perspective, while the Russian invasion of Ukraine did not immediately wipe out economic activity in Europe, the threat of Russia cutting Europe’s energy supply remains an economic risk important. After falling to very low levels last winter, Europe’s natural gas inventories have been growing at a typical rate for this time of year.
Storage was 62% full on July 9 and is on track to hit its 90% target by November, when winter heating needs typically hit.