Last week, our Chief Investment Officer Bill Henderson, was the guest on “Your Financial Choices” radio show. He discussed the first half of 2022 and the outlook for the remainder of the year. Listen to the recording at yourfinancialchoices.com and submit follow-up questions. LISTEN NOW
Earlier negative data on inflation (U.S. Consumer Price Index) for June 2022 +9.1% Year Over Year rocked the equity markets and pushed investors to the relative safety of U.S. Treasury bonds. However, by the end of the week, two new pieces of inflation data (Empire State Manufacturing Prices Paid and Consumer Inflation Expectations) both moved sharply lower indicating that inflation may have peaked, and the markets snapped back nicely on Friday, although not enough to end the week in positive territory. For the week, the Dow Jones Industrial Average fell –0.16%, the S&P 500 Index lost –0.93% and the NASDAQ fell –1.57%. We take a deep dive look at inflation below. The 10-Year U.S. Treasury Bond fell 16 basis points last week to close the week at 2.93% giving back investors 1.00% of return on the year.
Markets (as of 7/15/2022; change YTD)
Global Economy
President Biden’s trip to the Middle East will not be impacting oil prices anytime soon as he was unable to secure any reasonable increase in oil production from Saudi Arabia. A look at Chart 1 (from Haverford Trust and JP Morgan) shows Contributors to Headline Inflation since March 2021. Note: energy and shelter (housing) continue to be the largest contributors. Both can be easily impacted by prevailing market trends and quickly as is evidenced by gasoline prices retreating from recent highs.
Chart 1: Contributors to Headline Inflation
As noted above, we want to do a deeper dive into inflation data hitting the wires. Inflation can be broken down into “sticky” vs “flexible.” See Chart 2 below (from Haverford Trust and the Atlanta Fed) showing CPI broken into Sticky (shelter, healthcare, restaurants) and Flexible (energy, groceries, cars) components. What is important is that the larger share of the current inflation spike is flexible; and therefore, can come down quickly (again evidenced by the recent drop in gasoline prices. Further, see Chart 3 (from Haverford Trust) showing Major Commodity Prices and how they all are down dramatically from their recent highs.
Chart 2: Consumer Price Index (Sticky Inflation vs Flexible Inflation)
Chart 3: Major Commodities Prices
Lastly, as we mentioned last week, expectations for future inflation are drastically different than current inflation trends. Importantly, consumers and the markets are not pricing in continued hot inflation data beyond one year hence. See Chart 4 below (from Philly Fed, NY Fed, & Haverford Trust) showing the 1, 3, 5, and 10-Year Consumer Inflation Expectations. As the markets, consumers and Fed Chairman Jay Powell digest this predictive inflation data, we could see some stabilization in the markets. Watch for earnings releases and employment data as each of these could show where potential weaknesses exist.
Chart 4: 1, 3, 5 and 10-Year Consumer Inflation Expectations
Policy and Politics
The Federal Reserve is preparing to raise rates by another 75bps later this month to combat inflation, although a 100bps move is also on the table.
Senator Manchin struck down the Global Minimum Tax proposal, which would require a 15% tax on multinational corporations around the world.
What to Watch
THE NUMBERS
The Sources: Index Returns: Morningstar Workstation. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. Three, five and ten year returns are annualized. Interest Rates: Federal Reserve, Mortgage Bankers Association.
MARKET HEAT MAP
The health of the economy is a key driver of long-term returns in the stock market. Below, we assess the key economic conditions that we believe are of particular importance to investors.
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US ECONOMY |
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CONSUMER HEALTH |
NEUTRAL |
Q1 2022 Real GDP shrunk at a 1.5% annual rate according to the second estimate. The main factors that resulted in a decrease in GDP were a surge in imports and trade deficit highlighting that the U.S. is buying more goods from foreign countries. The July 2022 University of Michigan Consumer Sentiment (Confidence) Index hit 51, a level not seen since 2009 during the GFC, but up slightly from the June Index level of 50, an encouraging sign. |
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CORPORATE EARNINGS |
NEUTRAL |
The earnings growth rate for Q1 2022 was 9.2% — the lowest since Q4 2020 (3.8%). This estimate was revised upward from the previous forecast of 7.1% in April. All S&P500 companies have reported earnings — 77% reported a positive EPS surprise and 73% beat revenue expectations. The estimated growth rate for Q2 2022 is now 4.3% which would mark a new post-pandemic low; but still solidly in the “growth” stage. |
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EMPLOYMENT |
POSITIVE |
Total nonfarm payroll employment rose by 370,000 in June and the unemployment rate remained constant at 3.6%. Job growth was widespread, led by gains in leisure and hospitality, manufacturing, and transportation and warehousing. Employment in retail trade declined. |
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INFLATION |
NEGATIVE |
The annual inflation rate in the US accelerated to 9.1% in June, the highest since November 1981, from 8.6% in May and above forecasts of 8.8%. Core CPI increased by 5.9%, slightly below 6% in May, but above forecasts of 5.7%. The increase in CPI was driven by major surges in food and energy prices, as food costs rose by 10.4% and energy prices by 41.6%. |
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FISCAL POLICY |
NEUTRAL |
After passing a $13.6 billion package to support Ukraine a few weeks ago, the House approved an additional $40 billion military and humanitarian package for Ukraine. The bill was passed with 368 votes against 57 votes. The total of the two packages ($53 billion) is the largest foreign aid moved through Congress in over 20 years. |
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MONETARY POLICY |
NEUTRAL |
The Fed responded to the persistent inflation numbers by raising rates by 75 basis points, the highest hike since November 1994. The next decisions by the Fed will be data-driven based on future inflation numbers and estimated economic growth, but Fed Funds Futures are currently pricing in a 75 basis point rate hike. |
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GLOBAL CONSIDERATIONS |
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GEOPOLITICAL RISKS |
NEGATIVE |
Russia has defaulted on its debt as of Sunday, June 26th when the 30-day grace period on $100 million of interest payments expired. This is the first Russian default since 1918. Sanctions imposed by Western powers effectively isolated Russia and its financial system from Europe and the U.S. making it much harder for Russia to complete international financial transactions. |
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ECONOMIC RISKS |
NEUTRAL |
Supply chain disruptions in the U.S. are waning but the rising cost of oil due to the Russian- Ukraine war is likely to cause additional inflationary pressures not only on gasoline prices but also on many other goods and services. Starting in June, China has started to remove some restrictions in major cities to end the COVID-19 lockdown. |
The “Heat Map” is a subjective analysis based upon metrics that VNFA’s investment committee believes are important to financial markets and the economy. The “Heat Map” is designed for informational purposes only and is not intended for use as a basis for investment decisions.
“Great things are not done by impulse but by a series of small things brought together.” – George Eliot
Tune in Wednesday, 6 PM for “Your Financial Choices” with Laurie Siebert on WDIY 88.1FM. Laurie will welcome Realtor Carrie Ward, CIPS, TRC, MRP, RENE, to discuss: The State of the Real Estate Market (and Tips).
Laurie can address questions on the air that are submitted either in advance or during the live show via yourfinancialchoices.com. Recordings of past shows are available to listen or download at both yourfinancialchoices.com and wdiy.org.
Our CFO, Elizabeth Wilson, is a featured guest on the Sidetrade Finance to Futurist podcast July 4 episode. LISTEN NOW – 04 July 2022: The CFO as a Catalyst for Change – Finance to Futurist (sidetrade.com)
Despite catastrophic headlines globally such as the assassination of former Japanese Prime Minister Shinzo Abe, and the continued war ravaging Ukraine, the main market influencing issue is the seemingly unstoppable inflationary pressures worldwide. Further, China is again attempting to solidify its military grasp on Hong Kong. Regardless of these negative headwinds, the markets turned in a decisively positive week with the Dow Jones Industrial Average returning +1.8%, the S&P 500 Index notching +3.0% for the week and the NASDAQ returning a healthy +5.5% last week.
Markets (as of 7/8/2022; change YTD)
Global Economy
30-year fixed mortgage rates in the U.S. dropped for the second week in a row, from 5.70% to 5.30%. This is the largest weekly decline since the Global Financial Crisis, when rates fell from 5.97% to 5.53% in December 2008. Chart 1 shows mortgage rates over the prior year. This decrease reflects widespread recessionary fears and an obvious slowing in the housing sector.
Chart 1: Average rate on a 30-year fixed mortgage
Chinese annual inflation numbers surprised to the upside in June with China’s National Bureau of Statistics claiming that consumer prices rose by 2.5%, up from 2.1% in May and higher than the expected 2.4%. Production prices remained lower with 6.1% inflation, down from 6.4% in May and down from the recent high of 13.5% recorded in October 2021.
Last week, Federal Reserve Chair Jerome Powell acknowledged that the recent 75 basis point rate hikes increase the chances of an economic downturn in the foreseeable future. The stated idea behind this is to prevent a shift in consumer psychology that inflation will persist, which would create an inflationary feedback loop. Chart 2 shows consumers’ inflation expectations over the next one and five years; with the salient point being that consumers do not believe inflation to be long-lasting, at this point in the economic cycle.
Chart 2: Consumers’ inflation expectations
Policy and Politics
As Congress reconvenes in Washington this week, several items are on the agenda, including the potential codification of abortion rights into federal law, the onshoring of semiconductor manufacturers to the U.S. as part of the China bill, lowering prescription drug prices, and potentially raising taxes on corporations and high-income households.
What to Watch
THE NUMBERS
The Sources: Index Returns: Morningstar Workstation. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. Three, five and ten year returns are annualized. Interest Rates: Federal Reserve, Mortgage Bankers Association.
MARKET HEAT MAP
The health of the economy is a key driver of long-term returns in the stock market. Below, we assess the key economic conditions that we believe are of particular importance to investors.
|
US ECONOMY |
||
|
CONSUMER HEALTH |
NEUTRAL |
Q1 2022 Real GDP shrunk at a 1.5% annual rate according to the second estimate. This is the first contraction since the beginning of the pandemic. The main factors that resulted in a decrease in GDP were a surge in imports and trade deficit highlighting that the U.S. is buying more goods from foreign countries. This may be an indication that the U.S. economy has recovered faster than other countries. |
|
CORPORATE EARNINGS |
NEUTRAL |
The earnings growth rate for Q1 2022 was 9.2% — the lowest since Q4 2020 (3.8%). This estimate was revised upward from the previous forecast of 7.1% in April. All S&P500 companies have reported earnings — 77% reported a positive EPS surprise and 73% beat revenue expectations. The estimated growth rate for Q2 2022 is now 4.3% which would mark a new post-pandemic low; but still solidly in the “growth” stage. |
|
EMPLOYMENT |
POSITIVE |
Total nonfarm payroll employment rose by 370,000 in June and the unemployment rate remained constant at 3.6%. Job growth was widespread, led by gains in leisure and hospitality, manufacturing, and transportation and warehousing. Employment in retail trade declined. |
|
INFLATION |
NEGATIVE |
CPI rose 8.6% year-over-year in May 2022, the largest increase since December 1981. Core CPI recorded a 6.0% increase (down slightly from April). The increase in CPI was driven by energy, food, and shelter. After declining in April, energy increased by 3.9% over May and gasoline rose by 4.1%. |
|
FISCAL POLICY |
NEUTRAL |
After passing a $13.6 billion package to support Ukraine a few weeks ago, the House approved an additional $40 billion military and humanitarian package for Ukraine. The bill was passed with 368 votes against 57 votes. The total of the two packages ($53 billion) is the largest foreign aid moved through Congress in over 20 years. |
|
MONETARY POLICY |
NEUTRAL |
The Fed responded to the persistent inflation numbers by raising rates by 75 basis points, the highest hike since November 1994. Powell mentioned that another 50 to 75 bps hike is likely for July. The next decisions by the Fed will be data-driven based on future inflation numbers and estimated economic growth. |
|
GLOBAL CONSIDERATIONS |
||
|
GEOPOLITICAL RISKS |
NEGATIVE |
Russia has defaulted on its debt as of Sunday, June 26th when the 30-day grace period on $100 million of interest payments expired. This is the first Russian default since 1918. Sanctions imposed by Western powers effectively isolated Russia and its financial system from Europe and the U.S. making it much harder for Russia to complete international financial transactions. |
|
ECONOMIC RISKS |
NEUTRAL |
Supply chain disruptions in the U.S. are waning but the rising cost of oil due to the Russian- Ukraine war is likely to cause additional inflationary pressures not only on gasoline prices but also on many other goods and services. Starting in June, China has started to remove some restrictions in major cities to end the COVID-19 lockdown. |
The “Heat Map” is a subjective analysis based upon metrics that VNFA’s investment committee believes are important to financial markets and the economy. The “Heat Map” is designed for informational purposes only and is not intended for use as a basis for investment decisions.
“If people sat outside and looked at the stars each night, I’ll bet they’d live a lot differently.” – Bill Watterson
Tune in Wednesday, 6 PM for “Your Financial Choices” with Laurie Siebert on WDIY 88.1FM. Laurie will be joined by VNFA’s CIO, Bill Henderson, to discuss: 2022 Half-Year Review.
Laurie can address questions on the air that are submitted either in advance or during the live show via yourfinancialchoices.com. Recordings of past shows are available to listen or download at both yourfinancialchoices.com and wdiy.org.