Capitulating or Cascading?

Summer 2022 Market & Economic Commentary

If there was “nowhere to hide in Q1 of 2022,” as we led our Spring commentary, there was nowhere to run in Q2, but cash. With inflation continuing to run red hot and the momentum of sentiment accelerating into the pessimistic and or fear categories, global equities continued to sell off. Many began to align with the belief that a technical recession was all but certain once the Q2 GDP print comes in. The Fed has been in full-blown panic mode, raising short-term interest rates in 75 basis point chunks. The Fed Funds Rate, which was still at near zero (0-0.25% target) after the Fed’s January meeting at the top of the year, now stands at 2.25%-2.50%. Rising rates at the low and long-end of the yield curve pushed prices of all fixed income instruments down. And unlike Q1, now with the fear of recession gaining steam, credit spreads widened, pushing down prices of lower credit-quality bonds even more than Treasuries. The ultimate question is, is any other this done yet? Or are we continuing to move lower in stock prices (and valuations) and higher in interest rates? For the moment, both markets are getting a relief. Since the close of Q2, stocks have recovered about half of their Q2 losses and interest rates and credit spreads have largely done the same. Time will tell if this is just a short-term respite during and secular bear market, or if we really have seen the worst of it.

How the Markets Fared

  • The 10-Year Treasury Yield climbed another half-percent from 2.37% on March 31 to 2.89% on June 30.
  • Interest rates went on a wild ride with massive volatility.
  • Inter-quarter, the 10-Year hit a high of 3.48%.
  • Oddly, even with inflation fears running high, the TIPS market sold off with investors locking in gains and expressing more fear about the economy than in continued inflation.

  • Value indices (and industries) continued to lead growth by eight percentage points. Losses in value are less than half of those in growth for the year.
  • Small Cap Growth continues to be the hardest hit asset class / style. The Russell 2000 Growth index is now down 33% in the last 12 months.
  • Commodities may have peaked as fears of a global recession put a damper on potential future materials demand. Or, perhaps commodity prices were in a mini-bubble of their own.

A Look at the Numbers

  • Residential Housing markets are slowing nationally, as the effects of 5%+ mortgages get digested by buyers that got used to sub-3% interest rates. Is this indigestion? Or is housing the next market to roll over?
  • The ISM® Report on Business is still showing growth. The manufacturing report came in at 52.8%, still above the key 50% market indicating economic expansion. The services report surprised many with a 56.7% reading, actually imporoving from the prior month. The net result is that businesses may be more timid than they were 3, 6, and certainly 9 months ago, but they are not running for cover just yet.
  • Labor Markets are still drum tight. July jobs report shows a 3.5% unemployment rate with average hourly earnings rising 5.2% year-over-year. The U6 unemployment rate (those unemployed and underemployed) came in at a very low 6.7%.
  • Inflation: Still running HOT, HOT, HOT! June’s CPI was up 9.1% and core CPI was up a more reasonable 5.9 CPI typically lags PPI for final demand, which unfortunately grew at a multi-generational high of 11.3% in June, and the index for final demand, less foods and energy, was up 8.2%. All eyes will be on the upcoming July report which should be helped a bit by an easing in gasoline and other energy costs.
  • The Consumer Confidence Index dropped to 95.7 in July. The shocking thing about this report is not that we have dropped 13 points just since April and 33 points since last summer, it’s that the gap between the present situation index is 76 points! Consumers think their current lot in life is presently as good as it was back in 2016 and even better than it was in 2006, the exuberant free-spending year prior to the beginning of the housing bubble bursting and two full years before the start of the Great Financial Crisis. In contrast, consumers are presently as pessimistic about the future as they were in the summer of 2009 when housing prices were in the middle of their 35% decline and unemployment was soaring to just under 10%!

                                                                                                                        

PIERing Ahead…

In my conclusion last quarter, we warned of the effects of massive inputs into the economic equation, especially one so far out of balance. Well, since then the Fed has been pouring Atom Bombs onto Volcanos. And the financial press and talking heads on Capital Hill are doing nothing to calm nerves, especially as we start the last 90 days before the mid-term elections. You don’t expect the voice of reason to jump in here any time soon, do you?

No wonder consumers are feeling and acting schizophrenic. Valuations are reasonable if not cheap once again, but momentum is accelerating in the same direction as consumer confidence. Normally we go from one end of the pendulum to the other, not back to the norms of the middle. On the other hand, earnings have been continuing to grow. Can corporate America out run and out maneuver inflation? Something’s got to give. Either we are in far better shape than our worst fears would indicate, or we are speeding towards a cliff of an economic train-wreck. Believe it or not, my bet is “both.” With all the continued heavy-handed policy making, I suspect the coming decade will be full of big wins and losses. Fixes and failures. Lots of ups and downs. We’ve dropped the anvil into the kiddy pool, get ready to for the waves.

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