By Tim Courtney, Chief Investment Officer
Despite recession fears and inflation at its highest level in four decades, unemployment remains low and consumer spending has not faltered much.1 We are in a period of contradictory data, and good news (strong jobs report) is seen as bad news (impending rate hikes) and bad news (inflation fell, but is still above 8%) is seen as good news (rates won’t be hiked so high).2 In this commentary, we look at some of these variables and how they are being priced into the market.
Inflation: Consumer Price Index (CPI) data shows inflation has come down slightly to 8.5% in July. One source of relief comes from falling commodity prices.2 In June, commodity prices peaked and have since decreased around 10-15%.3 Another source of help is the strong dollar. As discussed in last week’s commentary, the dollar is up 11% year-to-date.4 Home prices may also finally be moderating as a result of interest rate hikes, following the 20.6% surge in March.5
While some investors see this as a turning point for inflation, it likely will not solve the whole problem. Labor and housing costs remain high, and much of these costs haven’t yet been fully worked into CPI. As such, we believe inflation will remain elevated well above the target inflation rate (2%) for some time.
Gross domestic product (GDP): Data from the Bureau of Economic Analysis revealed real GDP decreased for a second consecutive quarter.6 While some investors consider this to be a telltale sign of a recession, others are hesitant to make the call given the other strong numbers.
As recession talks grew, interest rates started to decline in June through July. The market celebrated this as lower rates mean higher valuations, and July turned out to be the best month for stocks since November 2020.7 However, there are multiple challenges to growth, and markets are well aware of potential contractions and lower earnings. We believe markets will remain volatile for the rest of the year, but that much of the weakness has already been incorporated into prices.
Consumer confidence: During the pandemic, many consumers purchased goods to enjoy at home. Now, spending on services is likely to increase due to pent-up demand. Airlines, restaurants, and hotels are all packed this summer — something you might not expect to see with consumer sentiment at an all-time low in June.8 However, in some cases, consumers are burning through savings to maintain their standard of living.9 Banks are beginning to set aside greater amounts of capital to provide for loan losses, but so far, there has not been a huge increase in defaulted loans.10 While inflation is currently consumers’ number one concern, it appears they have enough income and savings to weather the storm, for now.
There is not a clear consensus or data pattern indicating how markets should behave in the coming months. Recent news has often set the market off on the opposite path of what many would have expected. This makes us reiterate our stance that diversification within portfolios and sectors remains the most prudent course of action. If you have any questions, please contact your Exencial advisor.
- The U.S. Bureau of Economic Analysis (7/29/22) — Consumer spending
- The U.S. Bureau of Labor (7/13/22) — Consumer price index July 2022
- CNBC (7/25/22) — Gas prices are lower, but for the Fed and consumers, commodities still control inflation’s future
- MarketWatch (7/28/22) — U.S. dollar index (DXY)
- CNN Business (5/31/22) — Home prices rose by more than 20% year-over-year in March
- The U.S. Bureau of Economic Analysis (7/28/22) — Gross domestic product, second quarter 2022 (advance estimate)
- CNBC (7/29/22) — Stocks rally for a third day to cap a winning week, major averages post best month since 2020
- U.S. News & World Report (6/28/22) — Consumer confidence slumps in June to lowest level in more than a year
- The U.S. Bureau of Economic Analysis (5/27/22) — Personal income outlays April 2022
- CNBC (7/15/22) — Wells Fargo profit falls as the bank sets aside funds for bad loans, company’s shares drop
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