Last week, equity markets bounced back as investors regained confidence that the market, for a time, may have bottomed after retracing half of the summer rally. Energy shares came under pressure as oil declined mid-week to the lowest level since the start of the Russia-Ukraine war, but energy equity shares still managed a slight gain in the week. Consumer discretionary outperformed primarily because of the overweight of Tesla in the sector. The Federal Vice Chair Lael Brainard and Cleveland Fed President Loretta Mester delivered mid-week comments thought to be less hawkish than investors anticipated, moderating inflation fears.1,2 Lower energy prices are contributing to signs of inflation slowing, coupled with lower prices, especially transportation costs.
Last Tuesday, the Institute for Supply and Services released the latest business survey of August economic activity in the services sector. The newest reading increased to 56.9 versus the July reading of 56.7. The Business Activity Index rose by 1%, and the New Orders Index rose by 1.9% over the July readings. An encouraging sign that inflation is easing is that the Price Index decreased for the fourth consecutive month to 71.5, down 0.8 percentage points. While inventory levels are increasing, services businesses find it challenging to resupply their stocks. The Inventory Index rose 1.2 percentage points to 46.2 from the July reading of 45. However, the Inventory Sentiment Index fell three percentage points to 47.1, which is into contraction territory.3
On Wednesday, the US Census Bureau and the Bureau of Economic Analysis announced the trade deficit was $70.6 billion in July versus $80.9 billion in June. Exports were up $500 million and imports down $9.7 billion less than in June. Year-to-date, the trade deficit stands at $136 billion, an increase of 29.0 percent over the same time last year.4 Also, on Wednesday, the Bank of Canada raised its overnight rate by 0.75% to 3.25%. In its statement, The Bank of Canada acknowledged that while the headline rate of inflation had moderated from earlier in the year with falling commodity prices, it noted the core rate has increased. The headline CPI fell in July to 7.6% from 8.1%, primarily as gas prices eased. The core rate moved up to a range of 5% to 5.5% in July. It also noted that economic activity in the US has slowed, but the labor market remains tight, as it does in Canada. The governing Council still believes that policy rates will have to rise further in the coming months.5 On Thursday, the ECB followed through with rate hikes, raising deposit rates to 0.75% from zero. They also stated that the inflation rate was uncomfortably high and that further rate hikes were likely as Europe faced a winter recession and gas rationing.6
In another sign that labor markets continue to be strong, the US Labor Department reported that initial unemployment claims declined by 6,000 to 222,000, the lowest level in three and half months. Continuing claims for all programs also decreased by 23,283 to 1,414,849.7
The equity market will likely need third-quarter earnings for confirmation to move higher in the coming months. Rate increases have rattled the markets despite the US Fed repeatedly telling investors that it is serious about taming inflation. The hope most investors have is that moderation in the inflation data in the coming months will permit the Fed to ease the path to higher rates and possible recession. Suppose the CPI data, especially the core inflation print expected next week, comes in stronger than expected. In that case, the recent rally will likely fade as quickly as it appeared, supporting the aggressive tone in Chairman Powell’s Jackson Hole speech.
Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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