U.S. equities rebounded in July with the S&P 500 posting its best monthly return since November 2020. Stocks were higher despite recent economic data suggesting a looming recession. While economists consider a range of factors in formally declaring recessions, two consecutive negative quarters might indicate one has already begun. Unlike prior recessions, the labor market remains strong as unemployment sits at 3.6%.
The Russia-Ukraine war, which now has lasted over five months, has become a dangerous stalemate. Since Russia launched its full-scale invasion, Ukraine’s defense ministry has said that at least 140,000 residential buildings have been destroyed or damaged, forcing more than 3.5 million people homeless. On July 22, the United Nations and Turkey signed agreements with Russia and Ukraine to re-open Ukraine’s Black Sea ports and resume exports of grain, cooking oil and fertilizer in order to address the growing concerns of a global food shortage.
On July 27, the Federal Reserve announced another 75bps rate hike, in an effort to aggressively fight inflation without creating a recession. The recent rate hike brings the federal funds rate to its highest level since December 2018. Despite elevated inflation, supply and demand imbalances and broader price pressures, job gains have been robust and the unemployment rate remains low. At some point, the Fed will start to slow hikes as they remain committed to returning inflation to its 2% objective.
Optimism flowed through to the convertible market, with the best monthly performance we have seen since 2020. The convertible market is less equity sensitive than it has been in the past, but equity performance still drives returns.
Convertible issuance has been a hot topic over the last few years with record issuance levels in 2020 and 2021. The primary market has slowed significantly in 2022 but we have seen a number of companies test the waters with potential deals only to pull them given the market conditions. These companies and many more will still need capital to operate, and the convertible market remains one of the least expensive ways for them to raise that capital. We saw a few new issues in May and June, and we are optimistic that issuance will pick up through the second half of the year. We see an opportunity for companies to issue new convertibles in exchange for existing issues. This could be an accretive transaction for the company while extending or laddering maturities to be more manageable. For investors, we would see higher yields and lower premiums. In past downturns, the convertible market has been one of the first markets to rebound both from an issuance and performance perspective. This is because convertibles can be issued quickly and less expensively than traditional bonds or equity. The equity optionality allows investors in these issues to participate in the upside as the market recovers.
Lastly, M&A rebounded with deals closing, including Ericsson’s $6 billion acquisition of Vonage, and Healthcare Realty’s $7 billion acquisition of Healthcare Trust of America. Other transactions made notable progress in securing required regulatory approvals, and spreads on pending deals generally firmed in sympathy.
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Gabelli Funds, LLC
Gabelli's August 2022 update on the US market
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