Commentary provided by Mark Szycher, Vice President, Investment Specialist, AIG Retirement Services
Market Performance Snapshot*
(Week ending July 29, 2022, month of July 2022, and year-to-date)
- Dow Jones Industrial Average®: +3.0% | +6.7% | -9.6%
- S&P 500® Index: +4.3% | +9.1% | -13.3%
- NASDAQ Composite® Index: +4.7% | +12.3% | -20.8%
- Russell 2000® Index: +4.3% | +10.4% | -16.0%
- 10- year U.S. Treasury note yield: 2.65%
- Down 11 basis points from 2.76% on July 22, 2022
- Down 36 basis points from 3.01% on June 30, 2022
- Up 114 basis points from 1.51% on December 31, 2021
- Best-performing S&P 500 sector this week: Energy, +10.3%
- Weakest-performing S&P 500 sector this week: Consumer staples, +1.6%
- Best-performing S&P 500 sectors in July 2022: Consumer discretionary, +18.9%, Information technology, +13.5%, Energy, +9.6%
- Weakest-performing S&P 500 sectors in July 2022: Consumer staples, +3.1%, Health care, +3.2%, Communication services, +3.5%
*Past performance is no guarantee of future results.
Equities brush off negative GDP report to cap July rally
Markets waded through a slew of information as July closed, including earnings reports, the Fed’s latest rate decision, and the first official reading on second-quarter GDP. Equity indices continued their recent rally, ending the week and month in positive territory. All eleven S&P 500 sectors were positive for the week and month. Bond yields remained well off June’s highs.
- Equities powered through recession concerns, with the growth-oriented NASDAQ Composite particularly benefitting from declining yields (which can make equities’ discounted future valuations more attractive). The NASDAQ Composite has rallied more than 16% and the S&P more than 12% since their most recent closing lows in mid-June.
- The 10-year Treasury yield fell as low as 2.62% after the Commerce Department reported real (that is, inflation-adjusted) U.S. GDP declined for the second straight quarter. The yield ended the week at 2.65%, down more than 80 basis points since its 3.48% high on June 14, just before the Fed announced the first of two consecutive 75 basis point rate increases.
- The 2-year yield has also declined sharply from its 3.42% high on June 14. Since mid-July, the 2-year yield has been about 20 basis points higher than the 10-year yield. Some market observers believe an inverted curve, i.e., shorter-maturity yields higher than long-maturity yields, may be a harbinger of an impending recession. Further, the length of time the curve remains inverted is also thought to provide additional evidence of the likelihood of a future slowdown.
- According to the St. Louis Fed, the 5-year breakeven rate, a measure of future inflation expectations, remained fairly well-anchored in July at around 2.6%. Although 2.6% is slightly above the Fed’s 2% inflation target, 2.6% is certainly well below recent year-over-year headline inflation figures above 9%.
- U.S. benchmark oil prices fell about 7% in July on global economic growth concerns. Pump prices continued the downward path they started in June, declining about 60 cents/gallon.
- Natural gas prices had an active month on both sides of the Atlantic, with European futures swinging up and down 15+% amid concerns about Russia’s reliability in supplying gas. U.S. natural gas prices, which remain much lower than Europe’s, rose more than 50% in July as heat gripped the country.
- Other commodity prices, including copper and wheat, fell in July as economic growth concerns increased and agricultural supply concerns eased somewhat.
Fed hikes 75 basis points
As expected, the Federal Open Market Committee (FOMC) raised the federal funds target rate by 75 basis points (0.75%) to a range of 2.25%-2.5% and said ongoing increases will likely be appropriate. The federal funds rate is now back to its most recent high-water mark from the period spanning December 2018 through July 2019. The FOMC next meets September 20-21.
- In his post-meeting press conference, Chair Jay Powell said, “While another unusually large increase could be appropriate at our next meeting, that is a decision that will depend on the data we get between now and then.” He added, in a remark that cheered markets, “As the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases while we assess how our cumulative policy adjustments are affecting the economy and inflation.”
- Powell confirmed the current 2.25% to 2.5% federal funds target is “right in the range of what we think is neutral.” (A neutral policy rate is one which neither stimulates nor restrains the economy.) As to how high the Fed could raise rates, Powell pointed to the June Summary of Economic Projections, which indicated a federal funds target range of 3.25%-3.5% by the end of 2022 and 3.5%-4% in 2023—suggesting the Fed may now be beyond the midpoint of its tightening path.
- On the current state of the economy, Powell said, “I do not think the U.S. is currently in a recession. And the reason is, there are just too many areas of the economy that are performing too well.” He pointed specifically to the labor market: “2.7 million people hired in the first half of the year. It doesn’t make sense that the economy would be in recession with this kind of thing happening.” Powell did note some softening in labor market conditions, as well as slowdowns in consumer spending and housing, acknowledging that the path to bringing down inflation without triggering recession “has clearly narrowed … and it may narrow further.”
U.S. GDP declines for second consecutive quarter as inflation persists
On Thursday, the Commerce Department reported real (inflation-adjusted) U.S. GDP fell at an annual rate of 0.9% in Q2 (April-June), the second consecutive quarter of negative growth after a Q1 decline of 1.6%. While two consecutive quarters of negative growth is a rule of thumb for recession, the official designation is made by the National Bureau of Economic Research using a variety of factors. A second estimate of Q2 GDP will be released August 25.
- According to the Commerce Department, “The decrease in real GDP reflected decreases in private inventory investment, residential fixed investment, federal government spending, state and local government spending, and nonresidential fixed investment that were partly offset by increases in exports and personal consumption expenditures (PCE). Imports, which are a subtraction in the calculation of GDP, increased.”
- Of note, changes in private inventories reduced GDP by 2% in Q2 after reducing it by 0.35% in Q1, while adding 5.3% to GDP in 2021’s fourth quarter (when overall GDP rose 6.9%)—possibly reflecting an economy still working out supply chain and inventory kinks.
- Personal consumption increased 1.0%, though less than Q1’s 1.8% increase. Spending on goods declined 4.4% while spending on services increased 4.1%, as consumers continued to shift away from pandemic-constrained spending patterns.
- Real disposable personal income decreased 0.5% in the second quarter versus -7.8% in the first quarter. Consumers have maintained spending in part by drawing from savings as evidenced by the personal savings rate falling to 5.2% in Q2 from 5.6% in Q1.
- On Friday, the Commerce Department reported June’s Personal Consumption Expenditures (PCE) price index rose 1.0% monthly and annually—both the fastest pace in 40 years. Core prices, excluding food and energy, rose 0.6% monthly but remained more subdued on a 12-month basis, rising 4.8%.
- The report also found consumer spending rose 1.1% in June, but only 0.1% when accounting for inflation (still a pickup from May’s 0.3% real spending decline). Real disposable income fell 0.3% in June.
- The Labor Department’s Employment Cost Index—a measure of worker pay and benefits, and thus an inflation indicator—rose 1.3% in the second quarter after rising 1.4% in the first quarter. Over the past year, employee compensation costs rose 5.1%, the fastest on records dating back 20 years.
- Orders of durable goods—manufactured items such as appliances, aircraft, and autos—rose 1.9% in June, the eighth rise in the last nine months. Defense aircraft saw a huge jump; excluding defense, orders rose 0.4%.
- New weekly unemployment claims declined from the previous week’s upwardly revised total but remained higher than spring’s trendline. The figure was above 230,000 every week in June and July after being below 220,000 every week from February through May. Continuing claims have remained below 1.4 million since the end of April.
Corporate earnings continue to show economic headwinds, but generally less damage than feared
Investors greeted mixed tech company earnings with relief as economic headwinds appeared to reduce revenue and earnings less than many feared. Retail and consumer goods companies reported signs that inflation is altering consumer buying patterns.
- Apple topped expectations and reported margins above its own prior estimates, but also saw “some pockets of softness here and there,” in the words of CEO Tim Cook. The company expects revenue to accelerate in the current quarter.
- Microsoft fell short of revenue and net income expectations, but investors were heartened by the company’s forecast of double digit growth for its new fiscal year, which started July 1.
- Google parent company Alphabet missed earnings expectations due to slowing advertising spending and negative foreign-exchange impacts, but the stock rose as results were less negative than investors had feared.
- Amazon exceeded revenue expectations while reporting a loss for the quarter, largely a result of its soured investment in electronic vehicle maker Rivian. Amazon issued positive third-quarter revenue guidance, lending further momentum to the tech rally. Strength in ad revenues set the company apart from other tech names.
- Cloud revenue at Amazon, Microsoft, and Google grew strongly, but more slowly than in recent quarters.
- Facebook-parent Meta’s earnings highlighted the challenges facing social media companies as it missed consensus forecasts while also issuing downbeat projections for the current quarter amid ad spending headwinds.
- Meta noted one factor challenging ad spending is “the normalization of e-commerce after the pandemic peak.” Echoing that concern was Shopify, which swung to a loss and announced 1,000 job cuts—about 10% of its workforce.
- Walmart warned its earnings will suffer as inflation-impacted consumers spend more on food and less on higher-margin goods. Best Buy said its current-quarter and full-year sales and profit will fall short of earlier projections as inflation reduces demand for electronics.
- McDonald’s benefitted from some consumers trading down from sit-down restaurants, but also noted lower-income customers choosing more value menu items.
- Consumer-brands giant Unilever reported higher sales revenue but lower volumes as it raised prices amid rising costs. Kraft Heinz reported similar trends.
- Coca-Cola painted a more upbeat view of consumers, topping revenue and earnings expectations and raising its full-year revenue guidance as it increased prices and benefited from away-from-home purchases. The company’s CFO said, “We continue to see resilience and a lot of demand not just in the U.S. but across the world.”
- General Motors missed earnings expectations as many vehicles remained unfinished due to computer chip and other parts shortages. GM’s challenges were exacerbated by lockdowns in China, leading to sales in China falling by one-third. The company expects the manufacturing backlog to clear and customer demand to remain high in the second half of the year.
- Ford issued much more upbeat earnings which easily topped expectations. Despite some China challenges, the company noted supply chain improvements and higher sales of SUVs and crossovers among U.S. customers starved of inventory.
Looking back over the past three weeks of earnings, a few trends have emerged:
- Credit card activity suggests consumers continue to spend (that said, several banks added to credit loss provisions with the potential for economic turbulence ahead).
- Many consumers have shifted spending toward travel and other experiences away from home.
- Inflation may be pushing some consumers to shift spending to essentials and trade down in quality.
- Companies, particularly in the technology space, are reducing hiring and in some cases trimming workforces in anticipation of continued economic headwinds.
- Supply chains and inflation continue to raise input costs and challenge companies trying to meet demand and maintain profit margins.
- The strong U.S. dollar impaired earnings for many multinational companies.
Final thoughts for investors
The U.S. economy has clearly slowed, and as aggressive Fed rate hikes continue to filter through the financial system and economy, it could slow further. Yet the possibility of less aggressive Fed rate hikes in the fall has—at least temporarily—lifted investor optimism. Markets are still facing tremendous uncertainty about the path of the economy and inflation. Speak with a financial professional about staying on track toward long-term goals.
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