Reflections from a tumultuous July

July was characterised by volatility as investors grappled with an almost constant flow of market-moving news. Hostilities resumed between the US and Iran, pushing energy prices higher and reigniting inflation concerns. Against this backdrop, the Federal Reserve kept rates unchanged, although a shift in its communication unsettled investors. Earnings season also began strongly, but robust corporate results were overshadowed by concerns over AI investment and China’s technological progress. Despite sharp swings throughout the month, US large-cap equities finished broadly unchanged, with similar outcomes in Europe and Japan. The UK reached a fresh record high, while technology and emerging market equities underperformed.

Last month we discussed the de-escalation in the Gulf following the signing of the Memorandum of Understanding between the US and Iran on 17 June. Less than a month later, the agreement had unravelled. Iran launched strikes against several tankers transiting the Strait of Hormuz outside its territorial waters, prompting US air strikes. As events started to spiral, Iran retaliated and, in the process, killed several American personnel stationed in Jordan. Despite heightened rhetoric and repeated posts on Truth Social from President Trump, hostilities appeared to ease during the final week of the month. Brent crude finished the month at around $90 per barrel after trading close to $100 earlier in July. US Treasury yields rose with the oil price as investors priced in the potential for higher rates to combat inflationary pressures arising from oil markets.

July served as a reminder that significant geopolitical risks remain. The Strait effectively remains closed, with no clear route back to pre-conflict conditions. Meanwhile, a new front emerged in the Red Sea as the Houthis, an Iranian-backed group, threatened to disrupt Saudi energy exports, potentially adding further pressure to global energy markets and, ultimately, inflation.

Despite heightened geopolitical tensions, July’s US inflation data surprised on the downside, with annual CPI slowing to 3.5% from 4.0% in June, below market expectations but still above the Fed’s target. Nevertheless, the resurgence in energy prices meant investors entered the July meeting pricing almost a 40% probability of a rate increase.

The Fed ultimately left interest rates unchanged, but its communication proved more consequential than the decision itself. Chair Kevin Warsh has begun reducing the use of forward guidance, arguing that providing fewer signals about future policy preserves the Committee’s flexibility. While the approach may offer policymakers greater discretion, it also leaves investors with less visibility over the likely path of interest rates. The uncertainty was compounded by several Committee members dissenting in favour of an immediate rate rise, raising concerns that the Fed may be falling behind the curve.

Markets reacted accordingly. Short-dated Treasury yields declined as expectations for an immediate hike faded, while longer-dated yields rose dramatically as investors priced in persistently higher inflation and interest rates. Equities weakened, and by month-end markets had shifted to expecting a rate increase at the Fed’s next meeting.

On the corporate side, the second quarter earnings season was expected to deliver a second consecutive quarter of earnings growth exceeding 20% in the US, an exceptionally strong outcome by historical standards. Early results have broadly surpassed those already lofty expectations. Yet the most significant earnings release came from Alphabet, where investors largely overlooked another set of robust results and instead focused on the negative free cash flow driven by the extraordinary scale of the company’s investment in artificial intelligence.

Alphabet’s experience reflected a broader shift across the technology sector. Investors increasingly questioned not whether AI will transform the economy, but whether the unprecedented level of capital required to build AI infrastructure can ultimately generate an acceptable return. As a result, July saw investors reduce exposure across much of the AI supply chain. Nvidia relinquished its position as the world’s largest listed company to Apple, while US semiconductor stocks fell by 20% over the month. The sell-off was particularly severe in South Korea, where the equity index also declined by more than 20%, with memory chip manufacturers SK Hynix and Samsung leading the way down.

These concerns were compounded by developments in China. Reports indicated that Moonshot had developed a highly capable AI model using older hardware and at a fraction of the cost of leading US frontier models. Separately, reports that proprietary technology underpinning ASML’s advanced chipmaking machines had found its way into Chinese hands raised fears that China’s semiconductor capabilities could advance more rapidly than previously anticipated. Together, these developments challenged assumptions about the durability of today’s AI leaders and raised broader questions over whether the unprecedented investment currently being committed across the sector will ultimately deliver the returns investors have come to expect.

Bottom Line

Geopolitical risks, inflation and monetary policy continue to dominate the macroeconomic outlook. Meanwhile, investors are becoming more selective in technology, rewarding companies converting AI investment into earnings while questioning heavy spending without clear returns. We expect volatility to persist through August but remain positive on growth assets, particularly non-US equities, supported by strong and broadening earnings.

Noteworthy

What is happening in South Korea?

South Korea experienced one of the sharpest equity market corrections globally during July. Having been one of the best performing markets in the first half of the year, the South Korean market fell sharply as investors reassessed the outlook for artificial intelligence infrastructure spending. South Korea’s equity market is one of the world’s most technology focused, with memory chip giants Samsung Electronics and SK Hynix accounting for a substantial share of the market. Both companies reported exceptionally strong earnings, with SK Hynix’s profits increasing sixfold. However, the results fell short of exceptionally high AI driven expectations, triggering a wave of selling among South Korea’s highly leveraged retail investors. The decline was exacerbated by single stock leveraged ETFs, which enabled investors to take leveraged positions in individual companies. As share prices fell, the leveraged nature of these products amplified losses, prompting retail investors to liquidate positions and contributing to one of the South Korean market’s worst monthly declines on record.

New Labour

The “King of the North” arrived in Downing Street in July as Andy Burnham became Prime Minister following Sir Keir Starmer’s resignation. One of his first major decisions was the appointment of John Healey as Chancellor, a move that came after weeks of speculation that Shabana Mahmood would inherit the Treasury. Although the appointment was unexpected, markets reacted relatively positively, with Healey viewed, at least for now, as a pragmatic and fiscally credible choice. Attention quickly turned to what the new leadership would mean for the UK’s already strained fiscal position. Burnham has pledged to increase infrastructure investment, accelerate reindustrialisation and deepen devolution in an effort to lift the country’s long term growth potential, while Healey has stressed that these ambitions will remain consistent with the government’s fiscal rules. For investors, the key question is whether the government can deliver on its spending ambitions without undermining confidence in the UK’s public finances. With gilt yields already elevated, markets will be watching the Autumn Budget closely for details of how additional spending will be financed and whether fiscal discipline can be maintained. With public debt approaching 100% of GDP, Burnham may soon find that the UK Government is indeed “in hock to the bond market”.