- The latest GDP numbers are looking at the economy in a rearview mirror. We believe there is data to suggest that the worst may be over.
- Consumers, who are responsible for about two-thirds of the U.S. economy, remain the major bulwark against recession.
- The job market continues to be tight; housing is starting to slow, and oil prices have backed off.
- The core PCE is the Fed’s preferred measure of inflation, and its latest decline suggests the efficacy of the Fed’s rates increases.
- Best case scenario, the rate hikes accomplish the slowing the Fed would like to see, and we do not experience further deterioration in the financial markets.
Many investors have been sitting on the edge of their chairs for the last three months, wondering if the U.S. economy will have two-quarters of negative growth. Today’s GDP data answers their questions. The GDP for the second quarter fell 0.9%, which follows the first quarter’s drop of 1.6%. In common parlance, two consecutive quarters of negative GDP defines a recession. Technically, however, the National Bureau of Economic Research determines when recessions start and end. They look at a wider range of data used to determine GDP numbers. They have not announced that the economy is in a recession.
Federal Reserve Chairman, Jerome Powell, announced on Wednesday, July 27, a federal funds rate increase of 0.75%. We believe that this increase was already baked in the cake. We continue to be supportive of the Fed raising interest rates to curb inflation. It is doing a high wire balancing act by raising interest rates to curb inflation and achieve price stability without tipping the economy into a downturn. Two interest rate increases in one month suggest that some of the tightening may be in the pipeline and not yet seen in lower prices. Our sense is that interest rates may rise to 3.8% – 4.0% by the end of the year. During the current quarter, we look to inflation subsiding and monetary policy remaining tight. Chairman Powell remarked that demand is still strong, the economy will continue to grow this year, and that monetary policy is working to cool inflation and the economy.
The latest GDP numbers look at the economy in a rearview mirror. We believe there is data to suggest that the worst may be over.
- As of July 26, the S&P is up 3.90% for the month, the largest increase
since March. - Approximately 75% of S&P earnings are better than expected.
- The Nasdaq is up almost 5% for July.
- The S&P 500 broad market index forward price-earnings multiple is approximately 16.5 times this year’s projected earnings and 15 times next year’s earnings. These numbers are within the historical S&P range.
Consumers, who are responsible for about two-thirds of the U.S. economy, remain the major bulwark against recession. Retail sales rose 1% in June, more than economists expected, the same month that saw inflation at an annual pace of 9.1%, the highest in 41 years. They are also feeling better about the economy. Consumer sentiment rose in July, according to the latest data from the University of Michigan, from 50 at the end of June to 51.1 in July. Consumer inflation expectations, which look further down the road, also fell from 3.1% in June to 2.8% in July.
The job market continues to be tight. June job gains were 372,000. Unemployment is at 3.6%; there are 1.9 jobs available for every unemployed worker. Recessions are almost always accompanied with high unemployment. There were over 1.6 million jobs added in Q1 (not recessionary), and over 800,000 jobs added in the first two months of Q2 (not recessionary).
We believe that inflation is continuing to show signs of peaking. One of the major contributors to inflation is the price of crude oil. Early in June, the cost per barrel was in the $120 area. It is now around $100. Over the past month, gas prices have dropped 50 cents.
The housing market, another catalyst for inflation, has come back down to earth. New home sales in June were at a seasonally adjusted annual rate of 590,000. This is 8.1% below the revised May rate. The previous three months were revised down significantly. Pending home sales fell 13.6% in May, year-over-year, while sales of previously owned homes hit a two-year low in May.
The thirty-year-fixed-mortgage rate hit 5.81% in June, the highest level since November 2008. Although it has dropped slightly, the new rate seems to have prevented many first-time buyers from purchasing new homes. The 30-year mortgage rate was about 2% at the beginning of the year. The Fed’s interest rate policy seems to be working in slowing the housing market.
The Personal Consumption Expenditures Price Index (the PCEP), released on June 30, is down 4.7% from a year ago. It is a measure of consumer spending for durable and non-durable goods, as well as services. It uses a different statistical methodology from the Consumer Price Index. The core PCE is the Fed’s preferred measure of inflation, and its latest decline suggests the efficacy of the Fed’s rate increases. Best case scenario, the rate hikes accomplish the slowing the Fed would like to see, and we do not experience further deterioration in the financial markets.
Our Fortis Rally Watch report is now flashing a strong buy signal. The latest signal emerged over the past few weeks as lower quality stocks started to outperform higher quality stocks. The NASDAQ and Russell 2000 are starting to gain strength also. The above activity is consistent with investors beginning to show more of a risk-on attitude. The correlation between stocks, bonds, and commodities is also becoming more normalized. Over the past few months, one of the greatest challenges has been to diversify among asset classes that were moving in tandem. In other words, stocks were going down, bonds were going down, and commodities started showing weakness. During this “nowhere to hide environment,” our portfolios have held up exceptionally well. Currently, all of our strategies are beating the appropriate benchmarks.
We continue to recommend that investors remain patient and avoid making emotional decisions. There are numerous stocks with historically low valuation, attractive P&E ratios, and margin stability. There is also beginning to be a light of the end of the tunnel from a valuation perspective. The excessive overvaluation that plagued the market through 2021 is gone. Our conclusion: the market is fairly valued at present. We believe it is appropriate to begin strategically adding back equity exposure that was trimmed heading into the year.
