Market Overview
Global equities gained in August, as risk sentiment ebbed and slowed amid shifting market dynamics.
Markets got off to a tumultuous start in August, with global stocks suffering a steep sell-off that was initially triggered by events in Japan, where the country’s economic outlook had dimmed as a result of a weak yen that had raised the costs of key imports like food and fuel and had hurt consumer spending. The decision by the Bank of Japan (“BOJ”) in late July to raise interest rates for the second time this year, coupled with expectations that U.S. interest rate cuts were forthcoming, led to a rapid appreciation of the yen that forced several hedge funds and some investors to abandon the popular practice of borrowing yen at cheap rates to invest in higher-yielding assets elsewhere. While this forced selling jolted stock markets around the world, they rebounded quickly after the BOJ promised to refrain from further rate hikes as long as markets were “unstable.” In the month, the yen appreciated 2.6% against the U.S. dollar.
Developments in the U.S. also contributed to market volatility in the early part of the month after a weaker-than-expected report on hiring by U.S. employers in July stoked fears that the U.S. economy was headed for a recession and that the Federal Reserve (“Fed”) had kept interest rates too high for too long in its campaign to quell inflation. Global stock markets rebounded in subsequent weeks, however, with the release of encouraging domestic data on retail sales and inflation, which reassured investors that a “soft landing” for the U.S. economy was still likely. Markets received an additional boost when the Fed, in a highly anticipated announcement, stated that the time had come for it to cut its main interest rates from its current 23-year high. Though the Fed did not announce when the cuts would begin or how large they will be, the U.S. central bank was widely expected to begin retreating from its restrictive monetary policy stance at its next policy meeting in September with a 25-basis point (“bp”) cut. Notably, traders in the federal-funds futures market were pricing in four 25-bp rate cuts by the end of the year, according to data from CME Group. The yield on the benchmark 10-year U.S. Treasury note ended August at 3.91%, 13 bps lower than a month earlier.
Central banks in Europe also made news in August. In the U.K., where domestic inflation had been hovering near the Bank of England’s 2% target for several months, the British central bank lowered interest rates from a 16-year high with a 25-bp cut, though it warned that it would adopt a cautious approach to any future rate cuts. In Sweden, the country’s central bank lowered interest rates for the second time this year with a 25-bp cut and stated that as many as three more cuts were possible provided inflation remained subdued. Meanwhile, in the eurozone, data suggesting that inflation in the common currency bloc had fallen to its lowest level since June 2021 raised hopes that the European Central Bank will cut interest rates in September. In August, the yield on the 10-year German Bund, Europe’s principal safe-haven asset, fell 1 bp, ending the month at 2.30%.
With the new earnings season in full swing, investors were given the latest update on how interest-rate headwinds have impacted company profits. In the U.S., 79% of the companies in the S&P 500 Index that reported results topped consensus estimates, which was above the long-term average of 66%. The second-quarter earnings growth rate is estimated to have increased 11.4% from a year earlier. In Europe, 49% of the companies in the STOXX 600 Index that reported results posted better-than-expected earnings, below the 54% that do so in a typical quarter. The year-over-year second-quarter earnings growth rate is expected to have contracted 10.6%. In Japan, 63% of the companies in the TOPIX (“Tokyo Price Index”) reported positive earnings surprises, which surpassed the 58% beat rate over the past four quarters. The second-quarter earnings growth rate is estimated to have increased 5.2% from a year earlier. In Hong Kong, 57% of the companies in the Hang Seng Index registered better-than-expected earnings, surpassing the 49% beat rate over the past four quarters. The second-quarter earnings growth rate increased 8.9% from a year earlier.
Against this backdrop, equity markets in the developed and developing worlds advanced in August, with the former outperforming the latter. In the U.S., the S&P 500 rose but modestly underperformed, as optimism that interest rate cuts were imminent was partially offset by the ongoing rotation away from index heavyweight mega-cap technology stocks toward previously overlooked areas of the market. Notably, 61% of the stocks in the S&P 500 outperformed the index, compared to 14% that did so over the trailing 12-month period. Across the Atlantic, the pan-European STOXX 600 outperformed on expectations that major central banks worldwide will loosen monetary policy soon amid signs that the Continent’s economic growth and labor market were improving. In Japan, the TOPIX eked out a modest gain but lagged the broader global market index, as a stronger yen and its impact on corporate profits, especially from exporters, weighed on investor sentiment. Meanwhile, in emerging Asia, the MSCI China Index rose but underperformed, as foreign investors continued to flee China’s stock market due to worries about the country’s growing economic woes.
Real estate was the best-performing sector in August, as heightened expectations that U.S. interest rate cuts were imminent led longterm investors to bid up shares of high-yielding real estate investment trusts (“REITs”). Energy was the worst performing sector, as the stock price of oil producers fell on worries that slower economic growth in the US and China could reduce demand for crude oil.
Outlook
While much of the last few months could be characterized as a series of false starts to a monetary policy pivot, in our view, each month represents yet another tick forward towards deciphering the prevailing macroeconomic conditions that will underpin both the pace of economic easing as well as deceleration in inflation and eventual easing of monetary policy. Collectively, the last several months’ performance serves as an important reminder to take short-term reactions to changes in interest rate expectations in stride.
We maintain our investment outlook and believe the portfolio is designed to both structurally take advantage of compelling opportunities that span a wide range - from a budding resurgence of interest in defencive utilities that will power an electrified future - to the key enablers, including materials, services and technologies, that will both facilitate and benefit from increased investment in infrastructure. We remain highly confident and enthusiastic about our investment strategy and positioning for the long-term.
Moreover, while performance of infrastructure as an asset class, with its above average sensitivity to interest rates, has had a tough time keeping up, performance-wise, with broad-based growth equity indices recently, the combination of defensive business models, highly predictable revenues and cash flows, and strong inflation pass-through characteristics has demonstrated commendable resilience and we find the investment category trading at considerably more attractive valuations vis a vis broad market indices.
We believe this leaves publicly-listed infrastructure equities well positioned to benefit from a continued brisk pace of investment, with plenty of runway ahead, and an end to the rate-hiking cycle, when we expect eventual lower interest rates will be used to discount cash flows that have been adjusted higher either for regulatory or contractual inflation-adjustment, or the indirect benefit of inflation adjustment that tends to stem from owning and operating high fixed cost, long life assets.
The information contained herein provides general information about the Fund at a point in time. Investors are strongly encouraged to consult with a financial advisor and review the Simplified Prospectus and Fund Facts documents carefully prior to making investment decisions about the Fund. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Mutual funds are not guaranteed; their values change frequently and past performance may not be repeated.
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Equity securities will fluctuate in price; the value of your investment will thus fluctuate, and this may result in a loss. Securities in certain non-domestic countries may be less liquid, more volatile, and less subject to governmental supervision than in one’s home market. The values of these securities may be affected by changes in currency rates, application of a country’s specific tax laws, changes in government administration, and economic and monetary policy. Emerging markets securities carry special risks, such as less developed or less efficient trading markets, a lack of company information, and differing auditing and legal standards. The securities markets of emerging markets countries can be extremely volatile; performance can also be influenced by political, social, and economic factors affecting companies in these countries.
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Published on October 1, 2024.