Markets cooled on the sugar highs

US debt gets downgraded
Stocks recede on resilient economic data
Real estate slowdown in the US
Home improvement in the spotlight

The truly optimistic month of July was followed by the due correction in August – only to end the month on the optimistic tone, again. Pretty much all the global stock indexes have reached their low point in mid-August before recovering some of the lost ground by the end of the month. Investors could see the markets seesaw in the wake of stronger-than-expected US economic data, interest rates’ expectations and US credit downgrade among other developments. For the month of August, Developed markets’ stock index MSCI¹ World has retreated -0.84%, while emerging markets stocks’ index MSCI Emerging Markets has dropped -4.67%. At the same time, US bond yields have risen slightly, too, with 10-year US Treasury bond yields rising to 4.10% (3.95% 1 month ago), while German 10-year Bund yields ended at 2.47% (in comparison to 2.49% a month ago).

Fitch downgrades US

The beginning of August was marked by quite an extraordinary event of Fitch Ratings downgrading US debt rating from the highest possible AAA one notch down to AA+ rating, thus – at least the theory goes - indicating slightly higher chance of default on the US sovereign debt. Fitch is one of the three main credit rating agencies (together with Moody’s and S&P) and is widely followed by the investment community. Until now, only S&P had its US debt rating rated at AA+, having downgraded it back in 2011 after a highly charged political drama over the debt ceiling. Interestingly, the move by Fitch this time comes in full two months after another similar debt-ceiling showdown in Washington. As it could be expected, the decision was met with criticism from the US government and a surprise from many market participants on the timing, as many of the reasons given for the downgrade could have well been applied pretty much any time during the recent years. Either way, no matter the short term upset from the US Treasury, this downgrade will most likely have no substantial effect on the US Treasuries’ pricing or the US debt capital markets, in general.

Interest rates scare the investors out of stocks

During the month of August the largest economy in the world – the US – has been showing signs of economic resilience in the face of steeply hiked interest rates over the recent months. Unemployment data, retail trade figures forced the market participants to reconsider their previous estimates on short-lived high interest rates, as it is becoming evident that higher-than-usual interest rates may need to be kept for longer than expected. This is naturally putting the brakes on the equity valuations, as higher-for-longer interest rates mean discounted future profits of companies are less valuable thanks to higher yielding alternatives (e.g. bonds). As the market participants have been digesting the possibility of higher interest rates for the foreseeable future, some of the high-flying segments of the stock market took a hit. Evidently, the technology sector – especially the highly volatile segment of the unprofitable technology companies. In many cases, low interest rates over the years had caused many investors to look for alternatives, even if the alternative happens to be a company with forecasted profits far away into the future. Now that the interest rates are so much higher than in previous years, these companies look increasingly vulnerable. As some investors are re-focusing back to more traditional yield-bearing securities, the technology-heavy Nasdaq composite index took a larger hit of -7.4% by mid-August, before recovering bigger share of the losses by the end of the month.

Housing activity slow in the US

On the back of rising interest rates across the globe and locally in the US, the 30-year mortgage rates in the US (mortgages in the US tend to have fixed rates across the mortgage lifespan) have topped 7% - the highest level American homebuyers had to pay on their mortgage loans since 2001. This is bound to have a substantial effect on the US real estate market, as only one third of housing transactions are executed on all-cash basis (i.e. the rest of the two thirds of transactions involve mortgage financing). 33,4% all-cash ratio itself in the US is sharply up since the early Covid-19 days in 2020 April, when low interest rates caused only ~20% of homebuyers to avoid a mortgage whatsoever.

Coupling the high interest rates with the now-chronic shortage of housing supply in the US, the number of transactions, measured by Existing Home Sales in the US have fallen to the lowest level 2010, indicating a sharp slowdown in the US real estate market.

Existing Home Sales, millions

Source: Independent.com

Home improvement in the spotlight

This sort of background may not be the best for home-improvement leaders in the US - Home Depot and Lowe’s - which in spring have both lowered their profit expectations for 2023. The results for the 2023 Q2 have shown both of the companies experiencing slowdown in home improvement spending, thanks to housing market slowdown together with the inflationary worries by the consumers. However, the slowdown for now seems to be smaller-than-expected by the market participants and the companies’ representatives stay cautiously optimistic about the rest of the 2023 trading activity.

As the home-improvement sector is obviously a big ticket discretionary spending by the consumer, the surprises on the positive in this sector may bode well for the rest of the US economy, as this would indicate increasing consumer confidence and willingness to spend, hence the decreasing chances of severe recession ahead.

Market view

Luminor House ViewThere has been no major change in the market positioning by our investment team in August. We see the relative retreat in equities as a natural response to increased medium term competitiveness of the fixed income instruments. Should these circumstances be expected to continue, we would take appropriate steps to re-focus the investment portfolios to take advantage of the changed market realities.

Luminor House View

¹ Morgan Stanley Capital International (MSCI) is an investment research company which, among other services, focuses on financial market indexes.

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