Sunday, July 17, 2022

Economic and Market Update

  • Markets - We are in a Bear Market, which means the S&P 500 is down 20% or more from a recent high. Some analysts expect the S&P 500 to bottom in the 3400 to 3500 range, roughly 10% lower than current levels. I believe markets are going through a bottoming process now and would expect markets to find a bottom within the next 90 days. However, that is not something anyone can know for sure, and circumstances and data can change. Markets may move higher once the Fed signals that interest rate increases will be less aggressive or ending.
  • Recession - I believe we are in a mild recession. Many define a recession as two consecutive quarters of negative economic growth. First-quarter Gross Domestic Product (GDP) was -1.6%. The Federal Reserve Bank of Atlanta publishes GDPNow and estimates that second-quarter GDP will be -1.5%. We will get the next GDP report on July 28. I would consider a recession mild if unemployment remains below 5%. People with jobs have money to spend on goods and services. Consumer spending drives 70% of the economy. It would be difficult to have a deep recession with low unemployment. On average, recessions last 6 to 18 months. So, we may already be halfway or more through a recession.
  • The Fed - The Federal Reserve will end a two-day meeting on July 27 and is expected to raise interest rates by 0.75%. There has been talk that The Fed may raise by 1% after higher-than-expected inflation reports at the consumer and producer levels. The Fed has intentionally communicated its policy path, and I would be surprised if they deviated now. There is no August meeting, and there is reason to believe inflation could be meaningfully lower by the September meeting.
  • Inflation – Tuesday, the Bureau of Labor Statistics released the June Consumer Price Index (CPI), showing inflation at 9.06%, the highest rate in 40 years. However, data shows that inflation may have peaked and is moving lower. Monday, we got weekly retail gas prices from the Energy Information Administration (EIA), indicating average gas prices have fallen 7% to $4.74 over the previous four weeks. If you drive around, gas prices have fallen lower since this data was collected. The prices of other commodities such as oil, lumber, copper, and grains are also falling. Over time these lower commodity prices will work their way into retail prices. In earnings calls from several retailers, it was revealed that some have inventory surpluses and were lowering prices to clear excess. Remember at the beginning of the Pandemic when there was a run on toilet paper? Purchasing managers are people too. It seems that some retailers overordered during a period when they were uncertain what they could actually get due to supply chain constraints.
  • Politics – Politics, politics, all God's children got their politics. I manage client accounts in pursuit of the best risk-adjusted outcomes considering current and expected policies regardless of whose team has the ball. It is expected that Republicans will gain control of one or both houses of Congress. Markets often do better during periods of divided government as significant legislative and regulatory changes are less likely. Regardless of the outcome of an election, once the election has passed, so does the related uncertainty.
  • Other Data – Friday, we got the Index of Consumer Sentiment (ICS) from the University of Michigan. The index increased to 51 from 50 the previous month, not a lot but moving in the right direction. We also got the Retail and Food Services Sales report showing a 1% gain following five months of decline. These two data indicate that though consumers say they have a negative view of the economy, they continue to spend. In the coming weeks, we'll get more second-quarter corporate earnings results. There is an expectation that some companies will miss expectations and guide lower for the rest of the year. Analysts have already begun lowering year-end forecasts for corporate earnings and the S&P 500. In the coming weeks, we’ll get more second-quarter earnings reports which should give us more insight into the state of the economy.

  • Final Thoughts
    • The data suggests we are in a bear market and mild recession.
    • During a recession, the average drawdown for the S&P 500 is 30%; so far, we’re down 20%, making another leg down a reasonable expectation, but we can’t know that for sure.
    • Recessions typically last 6 to 18 months. Measuring from the January high, we may be closer to the end than the beginning.
    • Recessions are the shortest stage of a typical business cycle. During a recession, economic excesses and dislocations are corrected. The most damaging recessions are often associated with a problem in the financial system. This recession is part of the aftermath of the Pandemic and not distress in the financial system.
    • During the Pandemic, governments and central banks worldwide provided businesses and individuals with additional liquidity. As economies reopened, supply chain disruptions limited the availability of goods and services. The prices of the available goods and services rose in response to higher demand resulting in inflation.
    • Central banks worldwide are raising interest rates and removing monetary accommodation to combat inflation. Higher interest rates slow economic activity resulting in lower corporate earnings and stock prices.
    • As supply chains continue to normalize and inflation subsides, a balance will be reached, and central banks will become less aggressive. As things normalize, the economy and markets can grow again.
    • The war in Ukraine adds to the economic uncertainty. Any resolution to the conflict could go a long way toward improving the global economy.