Market index returns

Month to date since July 05, 2023 as of July 12, 2023

After a brief downdraft following the U.S. July 4th holiday, global equity markets resumed their upward trajectory. In the U.S., yields on 10-year treasuries briefly topped 4% for the first time since early March before tumbling on new data showing that disinflation is likely here to stay. The encouraging inflation data resulted in the U.S. dollar weakening to levels last seen in April 2022 and 1 year breakeven inflation falling to 4Q 2020 levels. While an earnings recession is widely expected for the second quarter, the first batch of reporters (including JPMorgan, Wells Fargo, and Citigroup) have shown encouraging results, reenergizing hopes for a soft landing. Real Asset classes climbed higher, led by Natural Resources equities. Global Real Estate securities and Commodities also performed well while Global Infrastructure securities matched broader equity markets returns and TIPS lagged modestly. 

Why it matters: Investors appear optimistic and volatility remains subdued across equity markets. Winning the battle against inflation would be a profound victory, but at what cost to global economic growth? Given precedent for a lag between monetary policy decisions and the observed impact on the economy, time will tell how things ultimately play out in the U.S. Elsewhere, economic growth is already stalling out: the German economy shrank by 0.3% in the first quarter, UK GDP contracted in May, and China can’t seem to restart its economic growth engine. Meanwhile, war in Ukraine threatens escalation at any time, especially as NATO looks to expand, which is likely to agitate Russia. We continue to advocate for diversification with a holistically managed allocation to listed real assets, which can offer exposure not just to current necessity-based assets needs – such as housing, utilities (gas, electric, water), and food supplies – but also to areas where new secular trends are emerging, such as the need for data centers, energy transition infrastructure, and metals for the accelerating electrification trend.

Digging deeper: First, we review encouraging U.S. inflation data that could help the U.S. Federal Reserve (Fed) end its current rate hiking charge. Next, we take a closer look at the oil market: who’s buying, who’s selling, and who’s distilling? We also opine on the issues occurring in the UK with their regulated water utilities. Finally, we identify changes in performance trends in listed real estate and consider their staying power.

• Inflation backs down. Will the Fed back off?: June U.S. Consumer Price Index (CPI) data was released this week and showed continued deceleration. The headline year-on-year print of 3.0% (below an expected 3.1%) fell from 4.0% in May and was the lowest read since March 2021. The month-on-month print of 0.2% was ahead of last month’s 0.1%, but below expectations. Core CPI (ex food & energy) also undershot expectations at 4.8% year-on-year, down from 5.3% in May and the lowest since October 2021. Further, following our review period, the Producer Price Index (PPI) data came in below expectations with both the headline and core year-on-year prints of 0.1% and 2.4%, respectively, dropping from May. While it seems almost certain that the Fed will hike by another 25 bps at their July 26th meeting, odds of additional hikes (as measured by the futures market) have diminished after these two releases.
• OPEC’s “withholding” tax: With all energy commodities we track (aside from natural gas) up this week, we’re dedicating this segment to current energy sector dynamics. First, U.S. producers in the Gulf of Mexico are likely to hit a new record on shipments to Europe which may exceed 2.1M bbls per day (bpd) this month. China has also been aggressively expanding imports of crude oil with June’s volume up over 45% from the prior year (the second highest monthly level on record). China has also been increasing distillate exports, with diesel exports recently averaging more than 300k. Additionally, India has been a voracious buyer of cheap Russian crude and then sells the refined product to Europe and the U.S. at very healthy margins. On the other hand, Russian oil exports have started to wane with next month’s seaborne shipments expected to fall to about 3.1M bpd from 3.7M bbl in April and May. While this decline seems to support their promise of reducing exports by 500k bpd, there are signs Russia is withholding crude for domestic refinement. While much news has also been made about Saudi Arabia extending its 1M bpd voluntarily production cuts through August, its imports of Russian fuel oil (2.9M metric tons in 1H 2023), vastly exceed the 1.6M metric tons imported from Russia for all of 2022.
• What’s lurking in the (UK) water: Water utilities in the UK have had tough go recently, with the largest privately-held UK water company, Thames Water, at risk of potential nationalization. Saddled with a mountain of debt, Thames Water has struggled to such an extent that shareholders agreed to provide £750M to shore up its balance sheet, reducing the odds of nationalization. Another privately-owned UK water utility, Southern Water, had its bonds downgraded by Fitch less than a week ago, though one of its largest investors agreed to provide £550M in new funding. Higher interest rates in the UK are already placing an additional burden on debt servicing, but newly proposed regulations are threatening exponentially larger fines (£250M up from £250k) for polluting public waterways (such as can occur with storm overflow). The solution could involve spending billions of pounds to upgrade water infrastructure.
• Reversion in REITs: We have noted reversals in listed real estate performance before, but some trends are becoming even more pronounced with office, regional malls, and hospitals in the U.S. the top performers to date in July. Not only were these property types among the worst YTD performers at the end of May, but hospitals and core office were the worst and second worst performers in 2022 (regional malls fared somewhat better). While listed real estate stocks do have a tendency for mean reversion, we would note there are a limited number of pure-play hospitals. We will be watching companies’ earnings reports closely to get a read on all segments of the healthcare property market. Office may not be out of the woods yet either; a recent report from McKinsey Global Institute estimates work from home trends could wipe out as much as $800B in value globally from office buildings, with San Francisco, New York, and London being the hardest hit.

What we are watching: Even as U.S. natural gas prices have fallen by over 50% this year, the infrastructure related to gas remains in high demand and we review a recent transaction for a liquified natural gas (LNG) export terminal. We also continue to watch economic activity in China closely as the country takes active steps to prop up its faltering property market along with other stimulative measures. Finally, with the NATO summit in Lithuania concluding this week, we consider who might be next to join the expanding alliance.

• Oracle of Omaha bets on LNG: Berkshire Hathaway is buying an additional stake in a Maryland LNG export plant from a listed U.S. utility (Dominion Energy) for $3.3B. This new transaction will increase Berkshire’s ownership in the facility to 75% from 25%. While the price might look a little light, when you have a value investor buying from a motivated seller (Dominion is looking to shore up its balance sheet), these things can happen. This single-train linear process facility, dubbed Cove Point LNG, is one of just seven plants in the U.S. that can export LNG. Even as Germany rapidly built new LNG import terminals last year in an effort to reduce dependence on Russian gas, much of the gas from Cove Point seems destined for Japan with long-term contracts in place with the likes of Tokyo Gas and Sumitomo.
• Exports from the East underwhelm: New data from China this week showed exports (as measured in USD) dropped by 12.4% from the prior year in June, worse than expectations of a 10.0% drop. This is the second month in a row that export volume has dropped. Furthermore, imports dropped by 6.8% from the prior year, well ahead of the expected 4.1% decline. This marks the eighth monthly drop out of the past nine months, with imports moving higher only in February of this year. On a somewhat positive note, most commodity imports were more resilient (though lower prices on some materials weighed) with crude oil imports jumping remarkably as mentioned earlier.
• Too little, too (stimu)late?: China recently took additional steps to support its troubled property sector. These include allowing loans to be extended by a year, reducing down payment sizes on residential loans, lowering interest rates on mortgages, and not allowing banks to downgrade loans. Those banks that do carry bad loans may see some relief from the government, but to what extent remains unclear. Some of these steps aren’t new, but they have been extended through the end of 2024. Chinese property stocks and broader equities rallied on the news. The supportive measures come on the back of cuts to China’s prime lending rate, which just occurred in June. Ambiguity shrouds additional stimulus expectations this year, though one prominent advisor to the People's Bank of China (PBOC) is calling for the focus to shift to consumption from investment, which could help its floundering import market.
• Is NATO in their future?: The NATO summit wrapped up this week where a passionate Ukrainian President Zelensky reiterated pleas for membership. After changing his outwardly-critical stance to one of “gratitude,” he left with additional security commitments and new weapons packages. Most NATO members appear reluctant to consider Ukraine for membership until the war is over, as membership today would trigger Article 5, placing all NATO members in direct conflict with Russia; however, Sweden moved one step closer to membership as Turkey agreed to drop their objections in return for Sweden’s commitment to increase their counterterrorism efforts and the lifting of arms embargoes on Turkey. Sweden joining NATO is still not a done deal, as both Turkey’s and Hungary’s governments still need to ratify the agreement, though both have publicly stated they will do so after their summer recesses.