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- Real Assets rose with Fed poised to cut
Market index returns
Week to date since July 24, 2024 as of July 31, 2024
Index definitions: Global Real Estate = FTSE EPRA/NAREIT Developed Index; Global Infrastructure = Dow Jones Brookfield Global Infrastructure Index; Natural Resource Equities = S&P Global Natural Resources Index; Commodity Futures = Bloomberg Commodity Index; TIPS = Barclays US TIPS Index; Global Equities = MSCI World Index; Real Assets Index = 30% FTSE EPRA/NAREIT Developed Index, 30% Dow Jones Brookfield Global Infrastructure Index; 15% S&P Global Natural Resources Index; 15% Bloomberg Commodity Index, 10% Barclays TIPS Index. Source: Bloomberg, DWS. Past performance is not indicative of future results. It is not possible to invest directly in an index.
Market commentary:
Global equity prices moved higher in the final week of July, aiding positive returns for the month. Equity rotation continued with value stocks outperforming growth stocks and small caps outperforming large caps for the week and the month. The megacap tech stocks also rebounded from the prior week’s negativity with the NASDAQ Composite Index posting positive performance of 1.5%. Equity market volatility remained elevated with the VIX ending the period at 16.4 while fixed income volatility increased over the week with the MOVE Index climbing to 99.4 from 94.8. Despite the U.S. Federal Reserve’s (Fed) Federal Open Market Committee (FOMC) holding interest rates steady at their July 31st meeting, investors hoping for a September rate cut were solaced by Fed Chair Powell’s speech, which was taken as more dovish than the accompanying written statement. The speech noted that the time to cut rates was “approaching” which supported a drop in US Treasury yields, especially in the front-end and belly (2-7 year) of the curve which fell 10-12 basis points. The 2s-to-10s curve remained inverted at -23, while 10s-to-30s steepened the most by moving up +1.6 to 26.9. Against this backdrop Natural Resource Equities outpaced Global Equities, while Global Infrastructure, U.S. TIPS, Global Real Estate and Real Assets trailed close behind posting positive returns of 1.2 - 1.5%. Commodity futures was the only of our coverage sectors that ended in the red at -0.8%, driven by weakness in agricultural commodities and natural gas.[1]
Why it matters: The soft landing narrative in the U.S. stands on shaky ground as weaker labor market statistics and ISM Manufacturing PMI still sub-50 point to a Fed that is suddenly behind the curve. The unemployment report, released on August 2, outside of our reporting period, saw Nonfarm payrolls rise 114k for July, below estimates of 175k. There were also net revisions of -29k jobs for the prior two months. The reading pushed the unemployment rate up to 4.3%, which was above expectations of 4.1% and was accompanied by weaker-than-expected average hourly earnings gains. The ISM Manufacturing PMI is an equally weighted composite of New Orders, Production, Employment, Supplier Deliveries and Inventories. Central banks in Canada, Europe, and the U.K. have started to cut rates already, with the Bank of Japan as one of the only outliers who has hiked interest rates, bringing them out of negative territory. We worry the Fed has been too stubborn in the face of clear softening in the labor market.
While global economic growth has remained positive the illusive unknown unknowns remain which could upset the apple cart. Geopolitical risks remain as the U.S. enters the final months of a divisive Presidential election with both Democrats and Republicans not even paying lip-service to reducing the growing debt burden which has reached nearly $35 trillion. The war in Ukraine grinds on as do conflicts in mineral-rich nations in Africa. In the Middle East, Israel’s (assumed) assassination of Hamas leader Ismail Haniyeh on Iranian soil and the (assumed) assassination of Hezbollah’s Fuad Shukr in Lebanon, risks further escalation of the proxy conflict with Iran. At the very least the strikes will delay ongoing negotiations as Haniyeh was Hamas’ negotiator in peace talks. Without minimizing the very real human cost of these conflicts, the economic peace dividend could shrink as trade becomes more expensive and governments spend on “guns over butter” by diverting funding to defense spending instead of developing human and physical capital that could fuel productive societies.
Macro Dive: First, we’ll review central bank activities, followed by a look at European growth metrics and finally an overview of U.S. macro indicators.
Why it matters: The soft landing narrative in the U.S. stands on shaky ground as weaker labor market statistics and ISM Manufacturing PMI still sub-50 point to a Fed that is suddenly behind the curve. The unemployment report, released on August 2, outside of our reporting period, saw Nonfarm payrolls rise 114k for July, below estimates of 175k. There were also net revisions of -29k jobs for the prior two months. The reading pushed the unemployment rate up to 4.3%, which was above expectations of 4.1% and was accompanied by weaker-than-expected average hourly earnings gains. The ISM Manufacturing PMI is an equally weighted composite of New Orders, Production, Employment, Supplier Deliveries and Inventories. Central banks in Canada, Europe, and the U.K. have started to cut rates already, with the Bank of Japan as one of the only outliers who has hiked interest rates, bringing them out of negative territory. We worry the Fed has been too stubborn in the face of clear softening in the labor market.
While global economic growth has remained positive the illusive unknown unknowns remain which could upset the apple cart. Geopolitical risks remain as the U.S. enters the final months of a divisive Presidential election with both Democrats and Republicans not even paying lip-service to reducing the growing debt burden which has reached nearly $35 trillion. The war in Ukraine grinds on as do conflicts in mineral-rich nations in Africa. In the Middle East, Israel’s (assumed) assassination of Hamas leader Ismail Haniyeh on Iranian soil and the (assumed) assassination of Hezbollah’s Fuad Shukr in Lebanon, risks further escalation of the proxy conflict with Iran. At the very least the strikes will delay ongoing negotiations as Haniyeh was Hamas’ negotiator in peace talks. Without minimizing the very real human cost of these conflicts, the economic peace dividend could shrink as trade becomes more expensive and governments spend on “guns over butter” by diverting funding to defense spending instead of developing human and physical capital that could fuel productive societies.
Macro Dive: First, we’ll review central bank activities, followed by a look at European growth metrics and finally an overview of U.S. macro indicators.
- Fed Watching: The Fed’s FOMC held rates steady at its July meeting. Fed Chair Powell’s speech was considered more dovish than the accompanying FOMC statement, which was less reassuring of the potential for a rate cut in September. Powell stated he was more confident in the disinflationary outlook and said that the move to cut rates is “approaching.” Regarding its dual mandate, the committee noted that the goals are moving into a better balance. The cooling labor market has seen a moderation of job gains and the unemployment rate ticked up, while making “some” further progress slowing inflation.[2] The Bank of Japan raised rates to 0.25%, from a range of 0 to 0.1%, at their end of July meeting, while also announcing a reduction in the pace of bond purchases. Following the news, the yen rallied versus the US dollar, hitting its strongest level since March. Given expectations of the potential reduction in rates by the US Federal Reserve, the market eyed a narrowing of the gap between Japan and the U.S., which could further support yen strength.[3] In a tight 5-4 decision, the Bank of England cut rates by 0.25%, down to 5% for the first time since 2020. Easing inflation allowed the bank to reduce rates from their 16-year high but they warned investors that the pace of cuts would unlikely match the pace of hikes in recent years.[4] As always, central banks promised to remain data dependent in setting monetary policy.
- Gold, Silver, Bronze: Second quarter GDP readings for Europe were released during the review period. GDP (quarterly figure annualized) for the Eurozone slightly beat estimates, coming in at 0.3% quarter-over-quarter (0.2% estimated), and 0.6% for year-over-year, versus expectations of 0.5%. The upside surprise was driven by a large 1.2% q/q jump in Irish GDP, which tends to be volatile. GDP surprises in France and Spain were tempered by weaker-than-expected results for Germany while Italy came in on the nose at 0.2% q/q. Tamping economic excitement was a report that Euro-area inflation quickened faster than expectations, which could weigh on the ECB’s decision to cut rates at their next meeting on Sept. 11-12. Consumer prices in the Eurozone rose 2.6% in July, versus 2.5% in June, and above expectations for a reading of 2.5%.[5]
- Waiting for a Spark to the ISM: As we noted, the ISM Manufacturing gauge came in at 46.8 for July, well below estimates of a 49.0 reading. This was the sharpest contraction in eight months. The weakness was most pronounced in ISM Employment which fell to 43.4, down from 49.3. This puts the U.S. ISM Mfg PMI in the 2nd (bottom) decile for readings since 1990. Better showings for non-residential construction (electronic manufacturing), corporate sales, and margin improvements suggest a possible rebound in the second half of the year as activity could have found a bottom. However, weaker signals from the labor market could put a rebound in doubt as unemployed consumers could cramp spending. Initial jobless claims and continuing claims both rose above expectations and versus the prior week and nonfarm payrolls disappointed for July overall. Also supporting hope for rate cuts was second quarter’s report that unit labor costs came in below expectations at 0.9% vs. 1.7%. Another positive note from the first quarter data recently released was non-farm productivity which came in above expectations at 2.3% vs. 1.8%.
Real Assets, Real Insights: We’ll start with a note about energy costs in the U.S., followed by a commodity deal for copper access, and finally CBRE’s 2Q bill of health for the U.S. office market.
- Paid to Wait: U.S. grid companies are paid a premium to have power plant generation capacity available for peak demand days. Capacity prices jumped to $270 per megawatt at the latest auction for the mid-Atlantic PJM grid, compared to $29 at the prior auction. This well exceeded estimates of $60 - $100. While this could provide a boost to profits for utilities, the consumer will be the one footing the bill. The cost implied is about 1.5 cents per kilowatt-hour of demand across the network. A major shift in expected demand for electricity underpins the jump in price. After leveling off for the past decade, demand has begun to pick up, driven in part by data center construction in the DC/Northern Virginia area. While data centers generate tax revenue for local governments, they aren’t as visible economic contributors as a factory which generates jobs for the community.[6] The expansion of AI and the growth of data centers and their energy needs could become contentious as upgrade and expansion costs are spread across the customer base.
- BHP Looking to Cop(per): BHP Group Ltd. teamed up with Lundin Mining Corp. to purchase Filo Corp to gain access to South American copper assets. The company is looking to diversify exposure away from iron ore and coal to gain a bigger share of the metals needed for energy transition. The deal, announced on July 31, 2024, will give BHP a 50% stake in Filo and the copper mine they own on the Argentina-Chile border, as well as part of Lundin’s neighboring Josemaria mine. The plan is to combine both operations to cut costs, a move seen gaining favor in the industry.[6]
- Back to Work: CBRE’s 2Q report for the U.S. Office market showed signs of a potential bottom emerging. Net absorption was 2.4 million square feet, which was the first quarter of positive demand since the third quarter of 2022. Asking rents also improved, while completions were down. The development pipeline for construction contracted for a fifth consecutive quarter. The largest office markets saw improvement year-over-year in leasing activity and tenants in the market. To illustrate this improvement, renewals accounted for 45% of Q2 leasing activity, well above the pre-pandemic average of 31%. In the midst of 2Q earnings reports, many office REITs have reported a similar pickup of leasing demand, especially in the NYC/Boston and Sunbelt markets.[7]
