Market Update July 18, 2022

Photo by Raphaël Biscaldi on Unsplash

Economic data for the week included both producer and consumer inflation coming in higher than expectations, and continuing the string of multi-decade highs, which have weighed on business and consumer sentiment. Jobless claims also ticked up again, off of cyclical lows. Retail sales also came in stronger than expected, as did consumer sentiment (with lower long-term inflation expectations).

Global equity markets were down on net for the week, with mixed reactions to economic and inflation data. U.S. bonds gained ground as yields fell back and the treasury curve inverted; foreign bonds were held back by a strong U.S. dollar. Commodities fell back due to continued recession concerns.

U.S. stocks fell back again last week, with a high inflation print and continued negative comments from corporate executives concerning the expected economic environment. Later in the week, stocks attempted a rally with stronger retail sales data as well as consumer inflation expectations that fell back from recent highs. By sector, declines in energy and communications of over -2% led the index downward, while defensive consumer staples, healthcare, and utilities were little changed on the positive side. Real estate fell back by roughly a half-percent.

Earnings season has begun for equities, with only a handful of companies having reported so far. But, it may become a two-pronged story based on which companies have or don’t have pricing power (and able to pass inflation through to consumers). It started off disappointing for several banks, due to lower investment banking fees and an increase in loan loss reserves, taken in anticipation of slowing economic growth and higher defaults. Net profit margins have also fallen back year-over-year, with rising input cost pressures (unsurprisingly, ‘inflation’ was mentioned by over 80% of S&P 500 companies on recent earnings calls). Per FactSet, from a sector standpoint, earnings growth of over 250% is expected in the energy sector (although that sector represents only 3% of the index). Then, removing financials, which are affected by releases of reserves last year, the rest of the index is expected to see mixed earnings growth results.

We now appear to be in the second phase of bear market concerns. Phase one included the impact of rising rates on economic growth, which has traditionally been a headwind on risk assets generally. Much of this appears to have been priced in by now, based on historical tendencies, and is generally seen as an earnings multiple drawdown. Phase two is the prospect of an ‘earnings recession’, which includes a decline in company earnings that can accompany or precede a recession. There hasn’t been much indication of the phase two part yet, but a drop in market expectations for earnings could be a sign. So far, earnings growth for Q2 and full year 2022 remains positive, at roughly 4% and 10%, respectively (per FactSet data). Growth estimates for full year 2022 and 2023 remain around 9-10% each. Of course, these are subject to potential change quickly. In a typical earnings recession, S&P earnings could decline by up -10% to -15%, so the current stats are much more optimistic, pointing to the ‘earnings multiple’ variety of slowdown, which has tended to be shallower and faster to recover, compared to the ‘earnings recession’ slowdown, which can be deeper and more drawn out. The forward 12-mo. P/E ratio has fallen to 15.8, which is right around the multi-decade historical average, but below the 10-year average of 17.0.

Foreign stocks underperformed domestic by a bit last week, held back by a stronger U.S. dollar. Developed markets fared better than emerging, which were pulled down by an -8% in China, tied to rising Covid cases and back-and-forth rhetoric with the U.S. In China, GDP grew by a meager 0.4% in Q2, well below expectations and the prior quarter. In addition to the extensive lockdowns this year, continued trouble in the real estate sector has dampened sentiment. On the positive side, the government has been quick to deploy stimulus to keep the machine in a positive direction, while careful to ensure funds aren’t targeted to problematic and speculation-prone sectors, like real estate. Another worthwhile reminder is that equity markets and economic growth results operate on different timetables (equity troughs have tended to lead GDP growth troughs by 6-12 months historically, with equities rebounding as economic growth is still finding a bottom).

There has been talk this last week about the euro achieving 1:1 ‘parity’ with the U.S. dollar, for the first time, since its creation in 2002. The weakness in the euro (-12% year-to-date) has been brought on by the obvious economic struggles on the continent and low relative interest rates compared to the U.S.—with a much more hawkish Federal Reserve. The same forces have been holding back the Japanese yen (down -17% ytd). Generally, when looked at in relative terms, a stronger economy and higher interest rates have tended to be bullish forces for a country’s currency, and vice versa. Continued calls for an eventual dollar coming back to earth have yet to materialize.

U.S. bonds fared positively last week, as yields fell back significantly (by 0.10-0.20%). Treasuries and investment-grade corporates fared similarly, along with positive results from high yield and bank loans as well. The treasury yield curve, at least as measured by the 10y-2y, has again inverted—to its widest level in 20 years (by 0.20%). In fact, the 2-year to 30-year area of the curve has been remarkably flat overall for weeks as the inflation vs. recession battle rages. Foreign bonds were again hampered by a rising dollar, with returns in developed markets tempered, and emerging market bonds falling back.

Commodities saw declines in all sectors last week. The price of crude oil fell by -7% to just under $98/barrel, which offset a strong rise in natural gas prices. Diplomatic meetings between President Biden and Saudi Arabia are intended to ease tensions between the two nations and open the oil faucet. The oil market has become complicated in recent months, with sanctions on Russian oil now causing those barrels to trade at a substantial discount to the broader world price. Supply has been snapped up by China and India at these cheap prices, as well as Saudi Arabia, which is using this oil for internal consumption, while exporting its own internal production. This is another example of sanctions having unintended consequences, while ‘price gouging’ is the political story in the U.S. for higher energy prices.

Period ending 7/15/20221 Week (%)YTD (%)DJIA-0.16-12.97S&P 500-0.91-18.27NASDAQ-1.57-26.50Russell 2000-1.40-21.76MSCI-EAFE-1.75-20.81MSCI-EM-3.69-20.54Bloomberg U.S. Aggregate0.89-9.80

U.S. Treasury Yields3 Mo.2 Yr.5 Yr.10 Yr.30 Yr.12/31/20210.060.731.261.521.907/8/20221.983.123.133.093.277/15/20222.373.133.052.933.10

Sources:  LSA Portfolio Analytics, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Deutsche Bank, FactSet, Financial Times, Goldman Sachs, JPMorgan Asset Management, Kiplinger’s, Marketfield Asset Management, Minyanville, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, Payden & Rygel, PIMCO, Rafferty Capital Markets, LLC, Schroder’s, Standard & Poor’s, The Conference Board, Thomson Reuters, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wells Capital Management, Yahoo!, Zacks Investment Research.  Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends.  Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.

The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness.  All information and opinions expressed are subject to change without notice.  Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product.