The US Fed hiked rates by 75 basis points, and the second quarter GDP contracted when most expected a slight increase, yet the equity markets recorded robust gains on the week. Comments from Fed Chair Jerome Powell in the post-meeting press conference gave hope for a 50- to 100-basis-point-increase in the Fed funds rate over the next three meetings, implying the rate of increase would slow in the latter stages of the year. Growth stocks outpaced value as retail stocks struggled, with comments from Walmart weighing on investor sentiment. The retailer’s guidance indicated that food inflation was slowing consumer discretionary spending. Apple and Alphabet posted better-than-expected earnings, giving the tech sector a boost.
With the second-quarter earnings season well underway, FactSet reports that 21% of the S&P500 companies have reported. Of the reporting companies, 68% have reported earnings per share (EPS) above estimates but below the five-year average of 77%. Companies are earning 3.6% above estimates, below the five-year average of 8.8%. As expected, the most significant contributor to the increase in positive earnings surprises came from the energy sector. Five sectors reported earnings decreases, led by the financial sector. Sixty-five percent of the reporting companies reported increases in earnings, which is below the five-year average of 69%.1
Last Tuesday, the Conference Board revealed that the July Consumer Confidence Index fell 2.7 points to 95.7. The present Situation Index reflecting consumers’ assessment of current business conditions and labor markets fell to 141.3 from 147.2 in June. Based on the short-term outlook for business, income and labor market conditions, the Expectations Index fell slightly to 65.3 from 65.8 in June. The primary contributor to the decline in the total consumer confidence reading was the Present Situation Index reflecting consumers’ concerns about rising gas and food prices. With rising interest rates, purchases for larger ticket items such as homes, cars and major appliances declined as well.2 The talk of a coming recession is causing consumers to adjust their spending habits. Also, on Tuesday, the Commerce Board reported new home sales dropped 8.1% from a month earlier to 590,000 versus expectations of 660,000. The median sale price increased 7.4% from June 2021, with 457,000 homes available, representing 9.3 months of supply versus 8.4 monthly supply in May. The largest drop in sales came in the West, where sales fell 36.7%, versus a gain of 42.3% in the Midwest.3 With rising mortgage rates, labor issues and higher material costs, affordability is slowing housing purchases.
On Wednesday, the US Census Bureau reported that manufactured durable goods increased in June by $5.0 billion or 1.9%, carried higher primarily by orders for new cars and military aircraft. A poll of economists by the Wall Street Journal had forecast a 0.4% decline in new orders.5
On Wednesday afternoon, US Fed Chair Jerome Powell announced the long-anticipated and expected 75 basis point increase in the Fed funds rate. The recent rate increase is the fourth increase this year in an aggressive move to slow the highest inflation in 40 years. He also suggested that there will be additional increases later in the year as economic indicators signal slowing economic activity. The tight labor market is the one indicator continuing to run counter to all others. The Fed worries wage growth could spiral out of control, further exacerbating inflationary pressures. While the GDP came in at a negative 0.9% for the second quarter, Fed Chair Powell said that he does not think the economy is in a recession and that a recession is unnecessary.6 In the past, two negative GDP quarters signaled a recession.
On Friday, one of the Fed’s most watched measures of inflation, the personal-consumption price index (PCE), showed an increase of 1% in June, bringing the year-to-date inflation rate to 6.8%. Ex-energy and food, the core index rose 0.6%, edging up the annual rate of inflation to 4.8%.7 Also, on Friday, the government said that consumer spending rose by 1% but, adjusted for inflation, increased just 0.1% last month. Consumer spending represents 70% of US economic activity, and if it remains positive, many think the US will not fall into a true recession.8
Once the economy slows to the satisfaction of the policy decision-makers, the hope is that the Fed will pivot and re-stimulate by lowering rates. With a tight labor market, war and a US election later this year, markets are unlikely to return to normal soon.
Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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