Investment Viewpoint: Markets pause in July, but the outlook remains resilient

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Markets and macro insights with Bernard Swords, Chief Investment Officer

Key takeaways:

1. Markets paused in July, with global equities down 0.6% in euro terms after a strong second quarter, as investors grew more cautious on inflation, interest rates and geopolitics.
2. Economic data continued to signal resilience, while uncertainty around central bank policy pushed bond yields to their highest levels of the year during July.
3. Corporate earnings remained a bright spot, with US and European companies reporting earnings growth ahead of expectations.
4. We view July’s weakness as a period of consolidation rather than a change in the broader investment outlook.

How did markets perform in July?

• After a very strong first half of the year, financial markets took a breather in July. Both bond and equity markets moved lower as investors became more cautious about the outlook for inflation, interest rates and geopolitical risks. While the market setback attracted attention, it followed an exceptionally strong second quarter and appears more consistent with a period of consolidation than the start of a more significant downturn.
• Bond markets came under pressure during the month, particularly government bonds. Euro area bonds declined by 1.4%, with much of the weakness linked to the escalation of tensions in the Middle East. These developments pushed Brent crude oil prices back towards $90 per barrel by month end, raising concerns that inflation could remain elevated for longer.
• Equity markets also experienced a period of consolidation. The technology sector was the main source of weakness, particularly semiconductor companies, which fell by approximately 16% during the month. However, this decline should be viewed in context, as the sector had risen almost 60% during the previous quarter. Higher bond yields also weighed on economically sensitive sectors, encouraging investors to rotate towards more defensive areas of the market.
• From a regional perspective, Asia Pacific was the weakest area, reflecting the heavy exposure of markets such as Taiwan and South Korea to the semiconductor industry. Elsewhere, performance was relatively similar across major regions, with the euro area holding up slightly better than many of its peers.
• Overall, global equities declined by 0.6% in euro terms during July, following gains of approximately 15% during the second quarter.

What did the economic data tell us in July?

• Economic data released during the month continued to point towards a resilient global economy. In the US, annualised GDP growth slowed from 2.1% in the first quarter to 1.5% in the second quarter. However, the underlying details were more encouraging, with domestic demand accelerating and growing at an annualised rate of over 3%. This suggests that the fundamental drivers of economic activity remain healthy.
• The euro area also delivered encouraging news. Economic growth improved during the second quarter and, excluding the volatility associated with Irish GDP data, expanded by around 0.3% quarter on quarter. This was almost double market expectations and represented a significant improvement from the flat growth recorded during the first quarter. While growth remains modest, the trend suggests that economic momentum is beginning to improve.
• China continues to be the weakest major economy. Growth is currently running at just over 4%, while recent business surveys suggest activity softened further during July. Manufacturing sentiment fell to 49.2 and the non-manufacturing index dropped to 49.0, both indicating a slight contraction in activity. Investors had hoped for further policy support from policymakers, but recent communications suggested a greater focus on implementing existing measures rather than introducing large-scale new stimulus programmes.
• Central bank policy remained an important focus for investors. The European Central Bank maintained its data-dependent approach while continuing to emphasise the importance of controlling inflation. In the US, communications from the Federal Reserve became somewhat more mixed, creating greater uncertainty around the future path of interest rates. As a result, bond yields moved to their highest levels of the year during July.

How are corporate earnings shaping the investment outlook?

• One of the most encouraging developments during the month was the continued strength of corporate earnings. Around half of US companies had reported second-quarter results by month end, while the European reporting season was also well underway.
• In the US, earnings growth was running at approximately 20% year on year, around eight percentage points ahead of expectations. In Europe, earnings were growing by roughly 18%, and even excluding energy companies, profits were still increasing by approximately 11%.
• Perhaps even more encouraging has been the outlook provided by company management teams. Nearly 60% of companies that have issued guidance have increased their expectations for the remainder of the year. This represents the strongest level of upgrades seen since the recovery period following the pandemic and suggests business confidence remains robust despite ongoing uncertainty.

What is the outlook for financial markets?

• While market performance during July was disappointing, we continue to view the weakness as a period of consolidation rather than a change in the broader investment outlook. We expect tensions in the Middle East to ease over time, which should help reduce pressure on energy prices, inflation and bond yields.
• More broadly, the fundamental backdrop remains supportive. The US economy continues to show impressive resilience, growth in the euro area is improving and global economic activity is expected to remain close to long-term trend levels over the coming years. Although China remains a source of concern, it is not currently sufficient to derail the broader global expansion.

The week ahead: what to watch out for

This week, investors will focus on a number of key economic releases, including US employment data, business sentiment surveys, euro area purchasing managers’ indices and retail sales figures. These indicators will provide an important early indication of how the global economy is performing as the third quarter gets underway and will help shape expectations for markets in the months ahead.