Market & Economic Commentary– July 2022
July 15, 2022
By, Peter Mueller & Steve Taddie
Back to the Future
There seem to be many things socially, economically, and related to investment markets that are swirling around these days which takes one back a few years. Of course, we focus on economic and market issues, where our advice and counsel matter, as those issues play into the financial plans of the individuals and businesses we serve.
This year, the markets have bounced back and forth between fears of inflation and fears of recession. There have been some crosscurrents with incoming economic data leading to swings in opinion, as the normalcy of supply and demand relationships have been upended by Covid related lockdowns and an unplanned war in Europe. For now, the markets seem to be hovering at a level where a mild recession is priced in. There does not seem to be much conviction to run much lower, nor is there much conviction to reverse course and run higher.
The stock market has moved ahead of the facts (as it usually does), after a modest 3.5% decline in the 1st quarter, the S&P 500 slid about 17% in the 2nd quarter, finishing June 30th down 20.6% for the year-to-date period. Wall Street analysts are now just beginning to downwardly adjust earnings estimates for S&P 500 companies; however, the herd has not yet followed suit. Wall Street analysts have always been a cheery bunch of glass half-full folks, and this time looks no different. The bond market has been in sync with the economic data, as hot inflation data and Federal Reserve (Fed) fueled upward pressure on short-term rates moved market interest rates higher across the maturity spectrum of bonds. As the possibility of a Fed induced recession has become more probable due to higher interest rates and tighter financial conditions, it is not certain. However, the US may already be in a technical recession (2 consecutive quarters of negative GDP growth), but we will not know until the National Bureau of Economic Research (NBER) post-dates the beginning and ending of a recessionary period. In reaction to the recession drum beating louder, interest rate expectations in the market now indicate that the Fed may move from tightening in 2022 to easing in 2023!
Inflation is not a uniquely American phenomenon, as inflationary pressures have challenged economies around the world. Global central banks have followed the Fed’s lead by raising interest rates and thereby tightening financial conditions to curtail inflation. It’s important to bear in mind that the Fed maintains a dual mandate, price stability (inflation vs deflation) and full employment. Today’s Fed is rightly hyper-focused on inflation above all else as the employment market remains healthy (96% of the labor force population is employed and jobs grew by 372,000 in June) and policymakers view the economy as strong enough to withstand tighter financial conditions and will therefore continue to raise interest rates over the near-term.
Rather than getting caught-up in the discussion of whether The Fed was late to removing policy accommodation, it is helpful to remember from 2010-2020, inflation averaged 1.70% (below the Fed’s goal), and the Fed telegraphed that it would rather err on the side of inflation than deflation, and that they did. So far, the combination of consistent rhetoric and methodical policy adjustments seems to have had the intended effect. As previously discussed, the national unemployment rate has been running at 3.6% for the last four months, and the number of unemployed persons remained essentially unchanged at 6.0 million. With the labor shortages oft mentioned in the press, and roughly half the unemployment rate experienced in the 1970’s, it is far easier for the Fed to have the political will to raise rates and slow things down in the economy a bit.
Month to month economic data is volatile, but revisions to prior reports are often revealing. Consumer spending is clearly not as strong as first indicated, and the inventory buildup we are seeing now at the retail level should slow price gains and tamp down production of those over supplied goods. While most commodity prices are up a lot on a year-over-year basis, the price of many commodities have fallen in recent weeks, such as recent declines in energy and basic materials prices. Inflation data released today for June (consumer price index: CPI) showed a 9.1% year-over-year increase led by record gas prices along with jumps in food and shelter costs. While this intolerable level of high inflation will not turn tomorrow, the data is backward looking and over the past few weeks we have seen some decreasing prices: energy, commodities, gasoline, etc. Should we continue to experience softening in real-time inflationary components, markets can begin to reprice, and sentiment may begin to improve as markets near a post- peak inflation and peak Federal Reserve tightening cycle narrative. Upcoming economic data will write this tale, but the recent “tea leaves” defining inflation are beginning to show some turn toward more normalized levels.
As for the markets, when they are up, we are happy, and when they are down, we are not. As investors we know that this is part of the process, and liquid financial markets are a major component of the successful capitalistic system we all participate in that allows us to own a part of the American dream, diversify our interests between asset classes, different industries, different companies, and different management teams. Typically invested assets have long time horizons, and many times, those time horizons outlive us as individuals. Sometimes the events of the day cloud the view of the longer-term nature of one’s investments. Keeping things in perspective while difficult during some periods, is always useful.
From an investment perspective, the volatility and declining markets has provided pockets of opportunity. These areas include higher interest rates (increase income) available to fixed income investors and lower share prices of quality businesses available to enhance portfolio quality for equity investors. We have been taking advantage of each pocket where applicable for client portfolios. Our investment goal remains to invest in high quality assets and businesses over multi-year periods (3+ years) which should enable us to invest through short-term volatility and difficult market conditions. We strive to invest in, not trade or time, high quality and defensible assets that are able to grow cash flow and earnings over multi-year periods. Investing requires perspective, patience, and perseverance – especially today. Going forward, security selection will become even more important as the era of everything moving upwards due to Fed liquidity appears to be behind us – we believe we own those quality and select investments that will generate return now and into the next economic and market cycle.
All the Best,
Steve Taddie Peter Mueller
The discussions and opinions in this correspondence are for general information only and are not intended to provide investment advice. While taken from sources deemed to be accurate, HoyleCohen makes no representations about the accuracy of the information in the letter or its appropriateness for any given situation. HoyleCohen’s quarterly statements are provided as a convenience and we encourage clients to refer to custodian statements as well.
Photo by Nadine Shaabana on Unsplash
