European stock markets continue to show signs of weakness after a turbulent week, influenced by fears of a recession in the United States and declines in Asian markets.
Weak U.S. employment data, along with disappointing tech sector earnings, have heightened concerns that the U.S. economy is slowing down. Investors are particularly disappointed that the Federal Reserve (Fed) did not implement a rate cut last week. Official U.S. employment data showed that jobs created in July were only 114,000, significantly less than expected, while the unemployment rate increased.
Realistically, the market reaction seems exaggerated, as the only change from last week was the Fed’s decision not to follow the European Central Bank (ECB) and the Bank of England (BoE) in cutting rates.
Investors are now clinging to this disappointment, using employment data to confirm their concerns.
The $50 billion sale of Apple shares by Berkshire Hathaway was also seen as a bearish signal, exacerbating market anxiety.
With these developments, a 50 basis point rate cut is now expected in the U.S. in September, compared to the initially forecasted 25 basis points.
The main question this week is whether investors are attempting a preemptive correction rather than facing a true downward spiral.
There has been much background noise, with a tendency to overinterpret a single data point.
It is important to understand that labor force participation is seasonal and that a broader perspective is needed to accurately assess the trajectory. The next round of data could potentially alleviate these concerns.
At the end of July, over 40% of S&P 500 companies reported their latest updates. At first glance, the results appear mixed. On one hand, only 60% of them reported earnings above estimates, below the ten-year average of 64%, according to FactSet.
On the other hand, 78% reported earnings per share (EPS) better than expected, a figure above the ten-year average of 74%.
This disparity between revenue and earnings suggests that profit margins are improving, and indeed they are. FactSet’s “blended” profit margin for the S&P 500 combines actual results from companies that have reported their earnings with estimated numbers from those yet to report. Currently, the figure for the last quarter stands at 12.1%. This is higher than the previous quarter and the same period last year.
Regarding profit growth, FactSet’s mixed data indicate that EPS for companies in the second quarter is 9.8% higher than the same period last year. If this data is confirmed at the end of the season, it would mark the fastest profit expansion since the end of 2021 and the fourth consecutive quarter of positive growth. This might be enough to convince investors that the strong rally in the S&P 500 over the past two years might still have momentum. However, it is becoming increasingly difficult to satisfy them the market’s reaction to positive surprises has been lukewarm this season, while investors have punished negative results more than usual.
In the calendar
- Monday Eurozone economic sentiment (August), UK services PMI (July). Earnings Palantir Technologies.
- Tuesday Japan household spending (June), eurozone retail sales (June), US trade balance (June). Earnings Uber, Caterpillar, Amgen, Airbnb, Rivian, Super Micro Computer.
- Wednesday China trade balance (July). Earnings Disney, Novo Nordisk, Shopify.
- Thursday China loan growth (July). Earnings Eli Lilly, Gilead Sciences.
- Friday China inflation (July).
What you might’ve missed last week
US
- The Federal Reserve (Fed) kept interest rates unchanged.
Europe
- Europe’s economy picked up by more than expected.
- But inflation in the bloc saw a surprise uptick.
UK
- The Bank of England (BoE) cut rates for the first time since 2020.
- In July, British factories had their best month in two years, with increases in both output and hiring.
- The newly elected Labour government hinted at future tax hikes and spending cuts to address a £22 billion budget shortfall.
- UK house prices rose for a third month in July, adding to evidence that the market is stabilising despite high interest rates.
- Rolls-Royce raised its profit forecast and reinstated its dividend for the first time since the pandemic.
Asia
- The Bank of Japan (BoJ) delivered its second rate hike of the year.
Why it matters
The FTSE 100 plunged heavily amid a global stock market crash triggered by weak U.S. employment data, which fuelled fears of a recession in the world’s largest economy.
For the eighth consecutive meeting, the Fed kept its federal funds rate unchanged at a 23-year high, between 5.25% and 5.5%. This decision might have contributed to the global markets closing in the red. Wall Street closed lower, with the Dow Jones down 1.52% and the Nasdaq down 2.43%. Tech stocks were particularly hit, with the tech sub-index recording a 5% loss.
The main pressure on the markets was the negative U.S. labor market data, with unemployment rising to 4.3% compared to the 4.1% expected. This fuelled analysts’ concerns about a slowdown in the U.S. economy.
Last week, the UK received its first interest rate cut since the pandemic, following a narrow five-to-four vote by the BoE. The central bank reduced the UK’s benchmark interest rate by a quarter percentage point to 5%, after keeping it at a 16-year high for a year to reduce inflation. However, this does not guarantee further cuts in the near future. In fact, the BoE did not indicate where rates might settle in the future or how quickly they will be reduced. The central bank instead warned that cuts must be made slowly and cautiously.
The Eurozone economy expanded by 0.3% last quarter compared to the previous one, matching the start-of-year pace and exceeding the 0.2% forecast. Although Germany, the largest economy in the bloc, recorded an unexpected 0.1% decline, this was offset by strong performances in Spain, France, and Italy. This might be enough to reassure cautious investors, after some had started to doubt that the region’s recent recovery still had legs.
Inflation data was less positive. A separate report published last week showed that annual inflation in the Eurozone slightly increased to 2.6% in July from 2.5% the previous month, defying economists’ expectations for a flat reading. Combining this unexpected jump with solid economic readings, which show that the region remains resilient in the face of high financing costs, the European Central Bank may see few reasons to rush into another rate cut. For now, traders still expect a quarter-point reduction at the bank’s next meeting in September.
Italian economic growth slowed to 0.2% in the second quarter, supported by domestic demand, and reached a 0.9% annual growth due to a strong services sector. The government remains cautiously optimistic, forecasting 1% growth for the year. The Prime Minister’s visit to China aims to strengthen trade ties by removing barriers for Italian products in the Chinese market. It is part of the country’s strategy to stimulate economic growth through international cooperation, especially in sectors like electric mobility and renewable energy.
In the luxury sector, Italian brands are showing some resilience. Prada, defying a broader slowdown in luxury, reported double-digit revenue growth due to strong sales in Japan and the growth of the Miu Miu brand. Similarly, Ferrari raised its annual forecasts with increased profits from custom and limited-edition car shipments. Lamborghini also reported record results due to a balanced approach to hybrid technology integration.
Japan’s benchmark index suffered its largest drop in nearly four decades.
The Nikkei 225 index in Tokyo fell by 12% today, marking its largest single-day decline since the Black Monday crash of 1987, while South Korea’s Kospi dropped by 9%. Stock indices in Australia, Hong Kong, and China also recorded significant declines.
The BoJ increased its benchmark interest rate to “around 0.25%”—the highest level since December 2008—from a previous range of 0% to 0.1%. Policymakers refrained from committing to further hikes this year, stating they will consider them only in response to evolving data and after assessing the impact of last week’s move.
Finally, the central bank outlined a plan to halve the amount of bonds it purchases each month, reducing it to about 3 trillion yen ($19.6 billion) by the first quarter of 2026.
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