July Market Commentary

On July 30, all the indices we monitor were negative except for the Stoxx Europe and the fixed income index, but on July 31, they rose so sharply that they ended in positive territory. Therefore, a last-minute relief.

• S&P 500: +1,13%
• Nasdaq: -1,63%
• Stoxx Europe: +1,32%
• All Country World Index EUR: +0,64%
• Global Fixed Income Index EUR[1]: +1,78%

What happened to make the markets end positive at the last minute? The FED came to the rescue, not so much by what it did but by what it said.

In his latest meeting, Chairman Jerome Powell kept interest rates at 5.25%. This alone was expected, but he then commented that there was a possibility of lowering rates, which triggered a buying frenzy on the last day of July. No one wanted to miss the opportunity and feel foolish. It’s like when a relative tells you they bought Bitcoin after it surged 30,000%, even though you know they didn’t use a rational decision-making process—it was pure speculation.

The FED argues they might start lowering rates because inflation has decreased and is nearing the famous 2% mark. On this point, I would like to make the following comments:

1. After lowering inflation from 9% in June 2022 to 3% in June 2023, it has remained in a range between 3% and 3.7% up to today. Therefore, we cannot claim victory, but it’s true that it has dropped significantly, thanks to the most volatile components like commodities or energy. However, some goods and services persist stubbornly and do not decrease. Moreover, it will be very difficult for them to drop because they have become entrenched in the economy. Allow me to give an example. If a restaurant, after its supply costs (inflation) increased, raised prices but did not lower them when those costs decreased because customers kept coming, then it is difficult for them to lower them again. These are the stubborn prices.
2. Commodities and Energy: I mentioned in the previous paragraph that the most volatile prices are those related to commodities and energy. These are essential costs for most companies and families, and their prices depend on several factors, mainly supply and demand. What has happened with the supply and demand of these goods?
   • Reduction in the supply of fossil energy sources (oil, coal, and natural gas): As a result of political decisions and pressure, especially in Europe, to transition to renewable energy sources, many companies have been forced to reduce their investments in fossil energy sources.
   • Maintenance of demand for fossil energy sources: According to the International Energy Agency (IEA)[2], the global demand for fossil energy sources still represents 80% of total energy consumption.
   • Therefore, if supply decreases and demand remains, the prices of these types of energy will rise, affecting inflation data. I believe promoting the transition to renewable energy is positive, but imposing it politically is dangerous—politicians gain votes, but citizens lose purchasing power. Something similar is happening with commodities.
3. Are interest rates being lowered because the battle against inflation has been won or because the economy is not doing well? We are seeing a negative trend in some economic data: three of the six monthly indicators published by the National Bureau of Economic Research (NBER) have changed from expansion to contraction. These are employment, manufacturing, and industrial production. The origin may lie in the increased financial cost as a result of the rise in interest rates between 2022 and 2023. It does not have an immediate effect; instead, the consequences can be seen in subsequent years when renewing loans (both corporate and personal). Many investors are concerned that central banks acted too late, and now we are closer to a recession.
4. Fiscal deficit can become inflationary: Since the pandemic, states have been increasing their public spending to levels close to 40%-50% of GDP.

Illustration 1. Own creation

In the case of the United States, tax revenues do not cover expenses, so other ways must be found to finance excess spending.

• Issuing debt: Perfect, but if credibility in the US economy begins to wane, creditors will demand a higher interest rate. If the cost is too high, then they can opt for…
• …money issuance: If I use money issuance to pay for goods resulting from the deficit (expenses exceeding revenues) and the producers of those goods hoard the money in their accounts, then it will not be inflationary, but if they spend it, it will enter the system, putting upward pressure on prices.

Every action has its immediate and non-immediate effects (those I called “unseen” last month), and when there is uncertainty, movements like those we are seeing these days occur. I love this cartoon by Bob Mankoff that very well illustrates what is happening.

This is what usually happens in the market in the short term. Only feelings produce market movements without much financial sense, but they impact investors’ optimism/pessimism. Speaking of the United States, the risk of having a monetary problem is very low because today the dollar is the world’s reserve currency, and its demand is very broad, starting with China. But if confidence in the American currency begins to wane, we would enter a very dangerous zone, although I think we are far from this hypothetical situation. Other countries are doing something similar, and their currencies are not world reserves.

Excessive spending financed by debt or money printing can be fatal for economic growth. It is difficult for us to think that a developed country could enter a spiral of severe economic and social problems. However, this makes me think of the sad situation in Venezuela, where what seemed impossible has become a reality. Venezuela is a clear example of what excessive public spending can bring, regardless of the political situation (which is undoubtedly the key factor that has led Venezuela to its current situation).

In 2001, Venezuela was the richest country in South America with one of the world’s largest oil reserves. In these 24 years of the 21st century, GDP has fallen by 55%, per capita income has dropped by nearly 50%, the minimum wage has plummeted by 99%, and nine million Venezuelans have had to emigrate[3]. Inflation has increased at an average annual rate of 800% during Nicolás Maduro’s tenure.

Illustration 2. Datosmundial.com

According to the macroeconomic data website “Datos Mundial”[4], the price increase in Venezuela from 2000 to today has been 9,704,093,733,978,516%. No, you didn’t read it wrong, and I didn’t make a mistake with the numbers. If an item cost 100 bolivars in 2000, today it costs 9,704,093,733,978,616. The loss of purchasing power has been more than 99%.

The country’s debt is now 300% of GDP, and despite having one of the largest oil reserves, today it needs an oil price of $120 to cover expenses.

This is the result of excessive discretionary spending to remain in power. Of course, this has nothing to do with the situation in other developed countries like the United States, but public spending is not something you can use at will because the results are catastrophic.

[1] Bloomberg Global Aggregate Index

[2] World Energy Outlook 2023 (iea.blob.core.windows.net)

[3] La izquierda española blanquea el caos de Venezuela | dlacalle.com

[4] Tasas inflacionarias en Venezuela (datosmundial.com)

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