Global Economy & Markets, Weekly Roundup 05/07/22

A valuation-driven equity market drop in Q2.2022, with S&P500 Price-to Earnings ratio declining to 16.1x from 19.6x 
              
Key Takeaways
 
Government bond nominal interest rates in core markets declined in the past week by circa 25 bps (10Y US Treasury: +2.9%, 10Y Bund: +1.15%) due to lower long-term inflation expectations. In addition, market-implied expectations for the Fed’s and ECB’s interest rates one-year ahead, have retreated by circa 60 bps respectively versus mid-June, to 3.0% and 1.25%, respectively. 
 
US real GDP growth in Q1 was broadly unchanged at -1.6% (from -1.5% in the advance estimate), albeit the details were unfavorable. Indeed, real private consumption growth was revised to +1.8% qoq saar from +3.1%. In addition, US ISM manufacturing new orders contracted for the first time in two years. For Q2, the Atlanta Fed’s GDPNowcast model points to near-stagnation (excluding inventories’ negative contribution).  
 
In the euro area, an important risk and intensifying source of concern, as cited, inter alia, in Germany’s prominent IFO business survey, is the possibility of natural gas flows from Russia being completely cut-off after having been reduced substantially recently, raising concerns for energy rationing and corporate defaults. According to Bundesbank, an abrupt halt to Russian energy deliveries could lead to a rationing of energy use, with 2022 real GDP declining by -2% under an unchanged fiscal policy scenario (European Commission baseline estimate for 2022: +1.6%). 
 
Note that natural gas storage levels as % of total capacity stand (as of July 3rd) at 62% in Germany. With electricity demand for air conditioning having entered peak summer period and, more importantly, with the flow of supplies increasingly at risk, the European Commission’s guideline for reaching 80% by November 2022, appears challenging. 
 
Note that the Nord Stream 1 natural gas pipeline (the major route of gas from Russia to Europe) is set to shut down from July 11th to July 21st for maintenance. In that context, Uniper SE (one of the biggest importers of Russian gas in Germany) is in talks with the German government for support, reportedly, via, inter alia, state guarantees for loans. The stock of Uniper SE has lost circa 70% of its value since a peak on February 11th and 49% in the past two weeks. 
 
In the second quarter of 2022, most investment strategies, including commodities, posted negative returns, as markets are getting more concerned about growth prospects than inflation risks. The S&P500 Energy index ended in negative territory (-6.1%, albeit for an excess return of +10% vs the headline index). The S&P/GSCI Industrial and Agricultural indices lost circa -25% and -12%, respectively. 
 
The prominent food price index from the Food and Agriculture Organization of the United Nations, have declined by 1.5% cumulatively in April & May, albeit still standing higher by +23% yoy. Wheat prices have declined by c. 26% as of July 4th, versus May’s average of $1228/bushel, in view of ongoing talks regarding a “grain export corridor” from Ukraine via Black Sea ports. 
 
Fixed income losses due to duration, as well as higher spreads, resulted in positive stock-bond correlation, with a typical 60/40 portfolio of US assets declining by -11% QtD. Since 1976, stock and bonds have declined simultaneously only in 19 out of 186 occurrences (quarters). 
 
Global Economy & Markets, Weekly Roundup 05/07/22
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