Stocks indices in the U.S. posted significant gains last week, led by a recovery in beaten-down technology companies. The Ark Innovation Fund ETF, $ARKK, gained 17.5% in the shortened trading week and the Nasdaq 100 ETF, $QQQ, jumped 5.4%. The S&P 500 lagged the powerful rally in growth stocks, but still advanced a respectable 3%.
The reversal in ARKK from the recent lows is encouraging for growth investors who are desperately looking for a bottom in prices. From its peak in February 2021 to its low in May 2022, ARKK fell an incredible 78%, mirroring the decline in the Nasdaq Composite between March 2000 and October 2002. There does not appear to be a single catalyst for the recent rebound, but investor belief that long-term interest rates may have already peaked in the tightening cycle has provided some much-needed optimism for the sector. Growth investors will want to see interest rates stabilize at or below current rate levels before long-term momentum can be established.
Additionally, the June payroll report, which confirmed the fourth consecutive month of job growth in excess of 400k, was sufficient to calm recession fears but not strong enough to warrant a change in the trajectory of the Fed Funds rate. Sentiment also benefited from additional potential stimulus from China. The Chinese Ministry of Finance announced plans to allow local governments to raise up to $220 billion in infrastructure bonds to promote growth.
A decline in global growth is a major concern for bond investors. 10-year bond yields fell to a low of 2.75% last week before reversing direction to close at 3.1% by the end of the week. Lower growth expectations are also reflected in both short and long-term breakeven inflation rates. The market anticipates inflation will average 3.22% over the next two years (down from near 5% in March) and 2.37% over the next ten (down from over 3% in April). The decline in inflation expectations, corroborated by the steep drop in many commodities markets, has no doubt contributed to the recent improvement in risk assets.
Meanwhile, European financial assets did not fare so well. The Euro approached parity to the dollar, falling to its lowest level against the U.S dollar in over 20 years due to investors’ ongoing concerns about energy shortages. The main gas pipeline between Russia and Europe is set to close next week for maintenance, and unless Russia gets some necessary parts, there is a worry that the flow of gas may stop entirely.
The uncertainty sent one-year forward power prices in Germany 9.25% higher on the week to a record 351 EUR/Mwh, which will pressure manufacturing costs and economic growth. Highlighting the stress was the latest release of German trade figures that showed a net trade deficit, the first such deficit since the reunification in 1991. In response, iShares German ETF, $EWG
The Euro is not the only currency under pressure. The U.K. pound also hit a new low, falling below 1.20. The dollar index, DXY is now up 16% year on year. The stronger dollar is a massive headwind to earnings for many large multinationals, especially the technology sector in the U.S., which gets roughly 60% of its revenue from overseas. In a recent note to clients, Morgan Stanley
Indeed, upcoming earnings are critical in determining the next move in the market. For the bounce in equities to hold, earnings and guidance will have to hold up to the lofty expectations still embedded in most analysts’ projections. With the strength in the dollar, the rapid build in inventories, and the deceleration in global growth, it is hard to fathom that earnings will come in as projected. Until there is some form of clarity around the impact of these negative shocks, last week’s rally may be short-lived.