By Tim Courtney, Chief Investment Officer

As volatile and negative as the markets have been over the last several weeks, all has not been in vain. There are signs that markets are making healthier, more sustainable decisions with capital. The most speculative areas of the market in cryptocurrencies and NFTs are being priced down¹ while the housing market seems to be stabilizing after buyers in 2021 went wild with rich offers.² Even the so-called “millennial lifestyle subsidies” (unrealistically low-priced services from money losing companies such as Uber and DoorDash) are ending and companies are raising fees to become profitable.³

Much of this change is largely due to the Federal Reserve raising rates from basically zero in 2020.⁴ Heading into the second half of the year, we will be closely monitoring the market’s reaction to this movement, as well as the three key themes outlined below:

1. Hurricane tracker: JPMorgan Chase CEO, Jamie Dimon, recently noted he is preparing for an “economic hurricane” and suggested investors to do the same.⁵ Will we go into a recession? The odds have meaningfully risen, but we don’t know when, the severity or the timing of the market’s reaction. We could be in recession now, although strong employment, income and spending numbers would make for a very strange recession. Rising rates and capital shifting away from less productive areas are having an effect, however. Housing starts have weakened and labor demands have begun to abate.^6,7 When a recession starts is anyone’s guess, but markets have already priced some level of recession.
2. Inflation: While the market has begun to focus more on recession over the last several weeks, inflation remains the theme of the year and is the primary driver of performance in nearly all asset classes year to date. Inflation accelerated at each reading this year, forcing the Fed to make good on their promises to raise rates, but there may be good news coming. While inflation will almost certainly remain elevated (not all of the recent housing price increases have made their way into the official inflation figures yet), there are some initial signs that it is peaking. Commodity prices peaked in mid-June, and longer-term interest rates have begun falling from their highs.⁸ If inflation has peaked and the market sees numbers that are still elevated but coming down, it will likely be seen as healthy progress by investors.
3. Earnings: There is still a big disconnect between market pricing and earnings estimates for 2022. Prices have fallen under the assumption that earnings must fall in a recession, but analyst estimates have been holding steady.⁹ We will be watching for second quarter earnings numbers and future guidance as they come in.

We still think inflation will ultimately determine market direction this year. If inflation begins fading, it will take pressure off interest rates and help stock and bond valuations. If inflation continues to force interest rates higher and higher, there will be increasing pressure on valuations. As always, if you have any questions, please contact your Exencial advisor.

For more on what we’ll be watching in the second half of the year, please join us on Wednesday, July 20 at 12 p.m. ET/11 a.m. CT for Exencial’s semi-annual client Mid-Year Market Outlook webinar. To register, click here.

Sources:

1. Yahoo! (6/19/22) — Crypto industry fears contagion as bitcoin slips back under $20,000
2. Time – NextAdvisor (6/17/22) — How to prepare for a slightly cooler summer homebuying season, according to 3 experts
3. MSN (6/13/22) — The end of the millennial lifestyle subsidy
4. CNBC (6/15/22) — Fed hikes its benchmark interest rate by 0.75 percentage point, the biggest increase since 1994
5. CNBC (6/1/22) — Jamie Dimon says ‘brace yourself’ for an economic hurricane caused by the Fed and Ukraine war
6. Reuters (6/16/22) — U.S. housing starts drop to 13-month low in May; building permits fall the Fed and Ukraine war
7. Bloomberg (6/25/22) — US layoffs, hiring freezes are tip of labor market slowdown
8. Bloomberg (7/6/22) — Commodities have lost 20% since June’s peak amid recession fears
9. S&P Global (6/30/22) – S&P 500 earnings and estimate report

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