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Markets were a sea of calm over July reflecting economic data that was largely in line with expectations and central banks taking a dovish tone. However, with many market participants concerned about the lack of volatility (the VIX fell to its lowest level since 1993), many wonder whether this is the just calm before storm. Both equity and bond markets delivered positive returns for investors over the month, at 1.5% for developed market equities and 1.7% for global bond markets. The U.S. S&P 500 reached a record high and delivered a respectable 2.0% for the month. Corporate credit outperformed sovereign bonds as the global economy continues to rumble on and central banks position to step away from super loose policies. Australian markets were largely insulated from global dynamics and returns for local markets were flat for the month. 
Exhibit 1: Asset class returns (local currency)

The local equity market under performed global peers during July and was effectively flat for the month at -0.01% on a total return basis, as the currency proved to be a strong headwind to returns. The Australian dollar rallied 4.1% against the U.S. in July and was up nearly 11% year to date, against expectations for sustained depreciation at the start of the year. Granted some of the Australia dollar strength was more about U.S. dollar weakness, but the resilience of the Chinese economy has seen steel demand improve and support inputs such as iron ore. At the sector level healthcare (-7.5%), utilities (-5.4%), telecoms ( 4.3%) and industrials (-3.2%) all had a tough month, while materials (3.6%) and financials (1.2%) were the best performers. Healthcare and industrials found themselves at the bottom of the list given the higher share of revenues generated offshore. Within the financials sector, the banks moved back into investors’ favour after the capital requirements were announced by the APRA, which were lower than had been anticipated (“at least 10.5%”). 
The ASX 200 is dominated by the banks and the mining companies in terms of market capitalization and generally when these two sub-sectors perform, it lifts the index as a whole. However, the market found itself at a loss despite the better performance of both banks and miners as it was not enough to offset the heavy losses elsewhere. The economy showed signs of a further move from the weakness in the first quarter of the year. Business conditions for June continued to rise as did retail sales and attitudes towards the resilience of the Australian household and its ability to spend. Importantly, the labour market has levelled off. The unemployment rate held steady at 5.6% in June but the composition showed that more jobs are being filled in full-time rather than part-time employment. This goes some way to alleviating the excess capacity issues and high levels of underemployment, which also fell in the second quarter. Just like many other markets, subdued inflation continues to be a bugbear of the central bank and the headline inflation rate dipped to 1.9% year-overyear in the second quarter. The weakness in inflation will not be enough for the Reserve bank of Australia (RBA) to move on rates as the cooling in the housing market was short lived and house prices nationally jumped by 9.6% year-over-year in June.

In fact, the RBA was quick to dispel any misinterpretation of hawkish comments during the month and strongly reiterated their lower for longer stance. 
Exhibit 2: World stock market returns (local currency)

International markets
The European economy continues to steadily improve, settling into an above trend pace of economic expansion. The purchasing managers’ indices (PMIs) for manufacturing in the region remains at a high level, with particular strength in the region’s largest economies of France and Germany. Despite this, after a strong run in the first half of the year, European equities underperformed its U.S. comparators in July and largely reflects the smaller weight of technology stocks in the index which have been a big contributor to U.S. equity markets gains.

Inflation continues to fall short of the European Central Bank’s (ECB) 2% target at 1.3% yearover-year. Even though rates hikes are still someway off for the ECB, we expect the central bank to announce a tapering plan for its bond buying programme in the coming months. Government bond yields fell in the single currency bloc over July and Italian bonds generated the greatest returns for the region despite ongoing political risks.

Investors outside of the region will be watching the currency closely when determining whether to hedge returns. The better growth prospects and weakening U.S. dollar meant that the euro was the strongest G4 currency in July, gaining 1.9% versus the greenback. 
Exhibit 3: Fixed income sector returns (local currency)

In the U.S., the themes of expansion in the manufacturing sector and the strong labour market continued. The latest release of the initial jobless claims confirmed that the labour market remains healthy and the U.S. ISM manufacturing survey is very strong. As in Europe, inflation is not living up to economists’ or the central bank’s prediction. Headline inflation in the U.S. was 1.6% year-over-year in July and has steadily declined over the past four months. U.S. Federal Reserve (Fed) Chair Janet Yellen, in her testimony to congress, outlined that the weakness in inflation was due to a “few unusual reductions” that could be more transient in nature and remained positive on the health of the labour market. We expect the Fed to announce the start of its balance sheet reduction at its September meeting.

The equities earnings season has been strong globally. At the time of writing, around 60% of the U.S. companies had reported their second quarter earnings figures. Earnings growth, has so far, been positive and year-over-year earnings-per-share growth tracking 9% for the S&P 500. In Europe the figure is 13%
Exhibit 4: Fixed income government bond returns (local currency)

Over in Japan, the Bank of Japan (BoJ) meeting ended without any strong market implications. However, the BoJ did make one notable change and pushed out the year in which it expects inflation to reach its target from 2018 to 2019. The Japanese equity market was helped by a weaker currency over the month as the yen declined by 1.7% against the U.S. dollar. But even without the currency support, the economy is starting to look stronger and the changes to the Japanese corporate culture may be factored into investor’s appetite for the equity market.

Emerging Markets

China surprised with stronger than anticipated growth figures for the second quarter and the economy expanded by 6.9% year-over-year. Retail sales and industrial production also came in  ahead of expectations at 11.0% and 7.6% respectively. During July, the MSCI Emerging Markets Index was the best-performing equity index globally, returning 5.0%. It was nearly matched by the MSCI Asia ex-Japan Index, which returned 4.7%.

Commodities ended the month up 2.3% thanks to rising iron ore, copper and oil prices. The price of oil has been moving back towards USD50 per barrel, with price fluctuations very much driven by the supply outlook. The price for Brent Crude in July was just above USD46 per barrel, but as U.S. shale production figures fell and inventory levels in the U.S. dropped by 10.2 million barrels, prices took another leg higher. OPEC has been doing its bit to create a floor for the oil price by reiterating its commitment to controlling supply through limited exports to the U.S. 
EXHIBIT 5: Index returns for July 2017 (%)

Originally published by J.P. Morgan Asset Management

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