Are rising interest rates beginning to have an effect on economic momentum in the US? Two data-points seem to suggest so – indicators that there’s a buildup of inventories and weak PMI survey data. This gives equity investors food for thought as we enter the Q2 earnings season, when particular attention will be paid to company reports and the outlook for the rest of the year.
Watch time: 5 minutes 23 seconds
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Hello, this is Jeremy Richardson from the RBC Global Equity team here with another monthly update. And what an interesting month June was. I think it was a month when the market really changed its stance. Worries at the beginning of the month between the tension between inflation and interest rates, particularly in respect of the US. Towards the end of the month, the fears of economic recession. And the catalyst for that was a couple of interesting data points we had mid-month, the first of which was a profit warning by Target, the significant US retailer, indicating that there were excess inventories and calling out that there were difficulties in clearing that excess inventory. Perhaps, a read out there for the strength of demand of the US consumer. And then secondly, weak PMI survey data, which is a tell really on the strength of US industrial demand.
Those two data points I think indicated that perhaps the rising interest rates that we're seeing in the US are beginning to have an effect and weakening economic momentum. And with that we can get economic momentum, naturally, the market has moved away from worrying about inflation to actually worrying now about the depth and extent of possible recession, particularly in the United States.
For equity investors, this comes at a really interesting, delicate moment because we now, as we are reporting this on the very cusp of the Q2 earnings season. I think investors will be paying particular attention to what companies are going to be reporting on as a guide to what the outlook for profits could be towards the end of the calendar year.
There's two things in particular that I would say that they're focusing on in the main. So, the first of which is around what the effect might be on profits of a stronger US dollar. Now, because we've got recessionary fears, naturally there is a higher degree of uncertainty in the market and to an extent investors have been favouring the US dollar as a so-called perceived safe haven, attracted by high US interest rates, certainly compared to those available in other international markets. That's great if you’re owning the US dollar, but if you're a US company doing business overseas, when those overseas profits are reported back and brought back into the US and reported in US dollars, the value of those is worth proportionately less. That's going to be a headwind particularly for those overseas earnings companies.
The second thing that investors are paying attention to, obviously, is the potential impact in terms of guidance of what companies expect to be generating in terms of profits for the second half of the calendar year, given these recessionary fears. I think that we just don't know, as we said, as we sit here, about how deep or long this recession could be if it happens, and what the guidance of companies is going to be. But we can take some comfort, perhaps, from the fact that the market has already reflected a lot of these fears. I would note that when Target reported its profits warning, the stock only fell 2% on the day, just reflecting the fact that some of this diminished outlook was already being reflected in the share price.
Where we go though from here for equity investors seems to be somewhat uncertain at the moment. I just want to highlight two things that we're seeing presently, which perhaps gives an indication of how the market is sort of positioned. The first of which is that there does seem to be a more defensive field for many investors. You see that in terms of the relative performance of multiple defensive sectors, the less economically sensitive sectors, and those companies with less market sensitivity have been doing comparatively well in increasing in terms of their valuation.
The second thing that we've been seeing is that you remember the whole narrative I'm sure, particularly at the beginning of the calendar year in the debate between growth and value is investment styles where there's lots of different types of value available. What we've seen more recently is that value has become more closely associated with energy and health, obviously by rising oil prices.
Now those oil prices seem to have rolled over, partly in response to expectations of lower demand as a result of these recessionary fears. It's interesting to see that in June, energy as a sector actually underperformed in the market. That's led to a much more balanced mix in terms of investment styles within the market. I think for equity investors that many will find themselves surprised by that data point because that contrasts with the strong narratives that many people talk about in terms of investment styles at the beginning of the calendar year.
For us, managing a global equity portfolio, we want the companies to be the heroes of the portfolio. We try and suppress and manage these sorts of extraneous inputs in terms of investment styles, geopolitics and so on, and the relative importance of that, I think it's never been more apparent given these of these volatilities.
We should be paying close attention to what we hear in terms of the earnings season, but for the moment at least, the portfolios seem to be very much well positioned in terms of the risks that it's facing off to. And we've been sort of reassured by the relative performance over the short term during this period of volatility. I hope that's been of interest and I look forward to catching up with you again soon.