The week started with equity markets under pressure from concerns about inflation and what US Federal Reserve Chairman Jerome Powell might say on Friday at the Jackson Hole Economic Policy Symposium. On Monday, the S&P 500 fell 1.2%, rebounding slightly mid-week, and then falling 3.4% on Friday after Powell sounded more resolute in taming inflation than the investors anticipated. The TSX held up the best, losing only 1.2% on the week with help from oil advancing 2.7%. In the US, meg-cap growth stocks dropped 5% for the week, falling 4.1% on Friday. In the meg-cap category, technology tumbled 5.6%, communications services lost 4.8%, and consumer discretionary matched the loss of communication services. Small and mid-cap stocks fared better than large caps. European equities continued their decline as inflation woes continued to plague investors. More than one European leader suggested consumers are facing a brutal winter ahead with natural gas prices at all-time highs and sustainable supplies questionable.
Notable economic reports for the week included Tuesday’s report from the Commerce Department on new US home sales in July, which fell 12.6% from June to a seasonally adjusted rate of 511,000. The July sales level is down 29.6% from July 2021 and the lowest since January 2016. The supply of new homes available for sale at 10.9-month supply is the highest since March 2009.1 On Wednesday, the Census Bureau reported that new orders for manufactured durable goods was flat for July. Shipments, unfilled orders, capital goods, and inventories showed modest increases from June levels.2 On Thursday, initial unemployment claims decreased by 2,000 from the previous week to 243,000. Continuing claims from all benefit programs fell 32,948 for the week ending on August 6.3 The latest reading indicates that the labor market continues to be very tight, which is one of the concerns for the Fed. If the labor market remains tight, wages may increase to attract workers contributing to inflation causing the Fed to raise rates higher to slow inflation. Also, on Thursday, the second quarter GDP was revised to -0.6% from the initial reading of -0.9%. The upward revision came from an adjustment to consumer spending and a slight increase in business inventories. The same report reported that adjusted pre-tax corporate profits increased by 6.1% in the second quarter.4 This is yet another sign that the US economy is continuing to expand.
On Friday, there was a flurry of announcements before the long-awaited comments from the Fed Chairman. The PCE price index, one of the Fed’s favorite indicators of inflation, fell 0.1% in July due to falling gas prices. The core PCE, which includes food and energy, fell 0.2% to 4.6% from 4.8%.5 For reference, the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflects changes in consumer behavior. Meanwhile, the headline CPI tracks a static basket. Also on Friday, the University of Michigan’s consumer sentiment index was also released on Friday and showed a climb to 58.2 from 51.5 in July. Consumer sentiment likely improved because of the expectation that inflation over the next year will increase by 4.8% compared to July, which showed an increase of 5.2%.
The speech by US Fed Chairman Jerome Powell on Friday morning shook the markets back to reality, even if just for a couple of days, when he made it clear the Fed will not be cutting rates anytime soon. Powell repeated previous comments about the need to take rates into a restrictive territory and to hold rates higher until the Fed is satisfied that inflation is headed to the Federal Open Market Committee’s 2% target. His firm remarks acknowledged the difficulty of reducing inflation and that it “will also bring some pain to households and businesses” and further the “historical record cautions strongly against prematurely loosening policy.” On the latest inflation decline in July, he said, “while lower inflation readings for July are welcome, a single month’s improvement falls far short of what the Committee will need to see before we are confident that inflation is moving down.”
In our opinion, a recession could happen in the future, and equity valuations may have extended a bit too far in the latest rally.
Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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