July 2022 Market Commentary

Is inflation out of control? In this month’s Market Update we look at why those with the least are being hit the hardest, and how the US Supreme Court’s recent Environmental Protection Agency ruling puts big investors in the hot seat on climate change.

Market Summary 

July saw the first positive month for global equity markets in some time. The FTSE World Index, representing the performance of developed markets, returned +6.42% over the course of the month. In the UK, the FTSE All-Share delivered a return of +2.34%, largely driven by Industrials and Consumer Discretionary companies whilst the Technology sector also experienced a small recovery. The US market, represented by the S&P 500 and the European market, represented by the Euro Stoxx 50, also experienced recoveries, returning +8.28% and +5.65% respectively. The Japan Nikkei 40 index increased 6.42% over the period whilst other Asian markets fell 1.06%. Emerging markets fared similarly, falling 1.36%. 

(All returns are sourced from FactSet and are reported as total return for the period 01/06/2022 – 30/06/2022) 

Is inflation out of control?  

"Among American families in the bottom 20% by income, almost 60% of their spending is on food, gasoline and housing. That is a far bigger fraction than among high income families."

As July progressed, we repeatedly saw inflation beating expectations and reaching multi-decade highs across countries from Australia to the US as the war in Ukraine rages on and continues to put pressure on energy and food prices. Central banks are raising interest rates at a rapid pace in an effort to control these price rises. This is combining to create a worry for economists as well as squeezing household finances.  

In the US, where inflation is 9.1%, those with the least are being hit the hardest as lower income families spend a greater proportion of their income on items where prices are rising fastest. Among American families in the bottom 20% by income, almost 60% of their spending is on food, gasoline and housing. That is a far bigger fraction than among high income families.  

Almost two-thirds of US inflation is linked to food, energy and categories of goods that had outsized demand during Covid-related lockdowns (and where supply chains are still struggling to keep up with that demand). In the Eurozone that figure is even higher at over 80%, and in the UK 75%. If these issues are indeed linked to discrete events such as the war in Ukraine or the Covid-19 pandemic, it is likely that inflation will fall back sharply at some point in 2023.  

The chances of a recession have increased but many markets have already moved to price in this probability as investors have remained cautious. We therefore believe that inflation is not out of control and some good news could trigger a market rally. This could be the successful export of some of Ukraine’s grain. However, on the downside, we remain wary of Russia’s ongoing engineering of volatility in energy markets.  

US Supreme Court Environmental Protection Agency ruling 

It seems bizarre that the regulatory body tasked with environmental protection matters has lost its ability to decide how best to limit key pollutants from the energy sector. However, the conservative majority US Supreme Court ruled exactly this on 30 June 2022. This was a landmark ruling, dealing a big blow to the fight against climate change.  

The Environmental Protection Agency (EPA) retains broad authority to regulate industry but it has sent a signal that policies such as the Clean Power Act, which sought to shift energy generation away from coal-fired power towards renewable sources, will receive greater scrutiny and potentially come up against greater challenges.  

"As the EPA’s authority has been somewhat diminished and Congress divided, asset managers have an increasingly important role to play in encouraging companies to go green."

On a positive note, at the end of July, Joe Manchin, a US Democratic senator who has opposed many of Joe Biden’s policies previously, made a surprise announcement that he was going to back a bill to raise corporate taxes, fight climate change and lower medicine costs. This move is a boost for Biden who remains focused on pushing ahead with climate change policies despite the Supreme Court ruling. 

The Supreme Court decision also puts big investors in the hot seat on climate change. As the EPA’s authority has been somewhat diminished and Congress divided, asset managers have an increasingly important role to play in encouraging companies to go green.  

Conservative leadership contest 

Liz Truss and Rishi Sunak are the two candidates who are vying to replace Boris Johnson as the UK prime minister. Both have said they will continue to support the UK’s ambition of reaching net zero by 2050, but beyond that it is difficult to know where they both stand on climate change or broader sustainability issues.  

Liz Truss previously held a cabinet role as Environment Secretary and introduced controversial cuts to subsidies for solar farms. While she has regularly spoken about the need to act on the climate crisis, she has indicated there is a need to focus on the UK’s energy security and has suggested that the UK may need to increase North Sea gas extraction.  

In his time as Chancellor, Rishi Sunak has used his Budget statements to describe new climate investments from the National Infrastructure Bank and the Net Zero Innovation Fund as well as the launch of the first sovereign green bonds. However, his voting track record on policies to tackle climate change paints a different picture; in February 2020 he voted against a proposal to eliminate transport emissions by 2030.  

It is unlikely either will prioritise climate policies ahead of the next general election which is due within the next 3 years. However, both can lay the foundations for government investment and greater focus on sustainability across the country as part of this government’s promise to “level up”. 

Conclusion 

Markets continue to be turbulent and inflation continues to rise. While the risks of a recession across the world have increased, we do think inflation will fall next year and a prolonged period of recession is unlikely.  

We feel that the investment opportunity in many of the companies that are aligned to our eight sustainable development themes is stronger than ever. As we have noted, a piece of good news, such as Joe Manchin’s change of heart, can lead to a bounce in markets and, whatever the outcome of the UK leadership contest, both candidates are committed to achieving net zero by 2050.