The Clouds Appear to Be Parting
The Clouds Appear to Be Parting
While only a fool would try to call for a return to the types of low market volatility investors experienced during 2017 and 2021, recent economic data is building an argument that fears of an economic meltdown or even a hard recession are likely misplaced. We walk through some of the recent good news and how a grasp of key data can help investors overcome common mistakes.
Five Things You Should Know
- Equity Markets – were higher this week with U.S. stocks (S&P 500) up 3.27% while international stocks (EAFE) rose 2.69%.
- Fixed Income Markets – were higher with investment grade bonds (AGG) up 0.38% while high yield bonds (JNK) rose 1.28%.
- CPI Report – equity markets rallied this week on data released this week showing inflation decelerated more than expected in July. The consumer price index was up 8.5% year-over-year in July, coming down from June’s 40-year high of 9.1%. Cooling gas prices appear to be the largest contributor and should give the Fed some breathing room and marks a step in the right direction for the Fed’s long-term inflation targets.
- Cooling Housing Market – existing home sales have moved down 14% since last year with mortgage rates steadily hovering around 5%. After a period from March 2020 to December 2021 where home prices soared over 30%, this sort of cooling has not been seen for some time. An 'interest rate hangover' from low rates may be felt for some time for new homeowners, where a more illiquid and slower housing market is expected to persist making moving more difficult in the future, according to Bloomberg.
- Key Insight – [VIDEO & ARTICLE] While only a fool would try to call for a return to the types of low market volatility investors experienced during 2017 and 2021, recent economic data is building an argument that fears of an economic meltdown or even a hard recession are likely misplaced. We walk through some of the recent good news and how a grasp of key data can help investors overcome common mistakes.
Insights for Investors
Intro – The Challenge
It’s a market that is testing everyone. Recency bias, one of investors’ biggest obstacles to success, has been working overtime this year to play on peoples’ fears – whether of loss or of missing out with each respective drop or spike.
How are you fairing? Are you trying to “figure it all out”? Did the announcement a couple weeks ago of a recession “trigger” you to act?
It’s not that an investor doesn’t need to change course from time to time, but it’s equally true that inaction is an action, and particularly during volatile times, sticking to one’s discipline and/or plan is a very conscious choice.
As we frequently caution investors, one key factor in differentiating acting from reacting is an honest evaluation of one’s current feelings and whether their decision is difficult. Buying surging markets is easy, selling into the storm is easy but both are detrimental to one’s long-term success.
The reason again to stay informed (thus these commentaries) is to do one’s best to understand the range of possibilities to avoid/abate surprises and consequent reactive choices, as well as to be armed with facts and history to help support a more disciplined approach.
So where do things sit today?
The Current Landscape
The big news of the week was Wednesday’s CPI report. Inflation’s path, and related expectations for the Fed’s aggressiveness (continuing to hike the Fed funds rate), are the largest drivers of market movements at this time.
As we’ve cautioned you back in June when inflation fears were at a fever pitch, the most likely reality was that was the peak, and it would abate over the back half of the year. And while it would be premature to give the all-clear, that is the story that appears to be unfolding.
This week’s report showed inflation unchanged for July versus expectation for a gain of 0.2%, and a year-over-year slowing from June’s +9.1% to July’s +8.5%. Key to the drop was the decline in energy prices that we discussed a couple weeks back.
The market’s hope, and thus large rally Wednesday after the report, is that this will give the Fed cover to slow the pace of hikes and still settle into a neutral rate between 3.25% and 3.5% (currently 2.25-2.5%).
What about that recession?
Scott Grannis, former Chief Economist at Western Asset Management, had this to say on the current state of the economy, “…there is very little evidence to suggest that the economy is in distress: swap spreads remain relatively low (i.e., liquidity is abundant, the opposite of what we would expect to see if monetary policy were actually tight), and credit spreads are only moderately elevated (i.e., the outlook for corporate profits remains healthy), and of course jobs growth remains robust (July job creation was surprisingly strong).” (See accompanying chart).
He continued stating, “Chart #1 shows that business activity in the all-important service sector of the economy (the source of about 75% of GDP) remains healthy. Not booming, but well above levels that would be consistent with a recession.” And in summary, “…the ingredients of a true, painful recession are missing. Jobs are growing by leaps and bounds (about 400K per month so far this year!), job losses are low, job openings are at stratospheric levels, industrial production is rising, capital spending is rising, the volume of world trade is at a new high, the stock market is recovering, and Covid-19 is yesterday's news.”
Regarding the US labor market strength, JPMorgan highlighted that, “Following a series of disappointing economic data releases, including a second consecutive negative quarter of GDP growth, the July Jobs report blew past expectations and underscored that the economy still has strong demand for labor and tight supply, which is pushing wages higher. Notably, the labor market has now hit two milestones, having recovered all the payroll jobs lost in the pandemic recession and achieving the lowest unemployment rate (3.46% to two decimals) since May 1969, as shown in the chart. Job gains were very widespread across industries with the bulk of gains in services … Still, the booming jobs report does provide strong support to Chairman Powell’s assertion that the economy is not currently in recession and we will need to see a softening in inflation data over the next few CPI reports (which we expect to happen) for the Fed to dial back its aggressive rate hiking path.”
As we discussed above, their latter point on improving CPI prints took a step in the right direction this week.
Whether one views the above information as definitively positive (if such things exist), it certainly is far better than was feared during the selloff in June.
As any regular readers know, investor sentiment and corresponding cash levels are something I like to follow closely. Of all the data points and corresponding principles, we follow I’m not sure I’ve found one better than fading the crowd.
Despite the relatively epic run off of the June lows, investor sentiment is still just neutral with bullish investors only increasing from 27% to 30% over the last few weeks and still far below AAII’s long term average of 38%.
Furthermore, cash levels (see chart below courtesy of Callum Thomas) are nearing similar peaks we’ve seen during other bear market lows. This metric is important because cash/money on the sideline, can be the fuel to propel markets higher.
In summary, while volatility is a tough part of an investor’s journey, to paraphrase Roosevelt, the only thing they really need to fear is the fear of volatility itself and the emotional reactions it can lead to. Fears of an impending collapse are simply not justified by the current data. When one considers that inflation is cooling, monetary supply growth is abating, credit spreads are narrowing, 87% of S&P 500 companies beat earnings expectations for Q2, and the Fed still has room to hike rates and still pull off a “soft landing”, it all should help quell the fears the perma-bears would have you embrace.
Have a wonderful weekend,
Tim and the team at TEN Capital
Data, Just the Data
Data points this week included:
- U.S. Jobless Claims – jumped by 14K to a claimant count of 262K for the week ending August 6th. This was slightly lower than forecasts of 262K, but the highest reading since November 2021. The four-week moving average has increased 4.5K to 252K.
- U.S. PPI Final – producer prices fell (0.5%) MoM for July. This is the first decline in two years, thanks mostly to gas prices dropping (16.7%). Cost of services slightly rose by 0.1% with transportation and warehousing services ticking up 0.4%. YoY, producer inflation slightly fell to 9.8% – the lowest since October and beating forecasts of a 10.4% rise.
- U.S. Consumer Sentiment – the Univ. of Michigan consumer sentiment rating bumped up from 51.5 in July to 55.1 for August. This handily beat market predictions of 52.5, but the current economic conditions subindex fell from 58.1 to 55.5. The 5-year inflation outlook slightly rose from 2.9% to 3%.
- U.K. Industrial Production – contracted by (0.9%) MoM for June. This comes after a 1.3% rise in May, but slightly beat expectations of a (1.3%) decline. This is the lowest reading since June 2021, with mining and manufacturing falling (1.8%) and (1.6%), respectively. Conversely, output in electricity, gas and air-conditioning rose 3.1% and water supply climbed 0.5%.
- Eurozone Industrial Production – bumped up 0.7% MoM in June, which was slightly lower than May’s reading of 2.1%. Production increased for capital goods and energy but decreased for durable and nondurable goods. Within the bloc, Germany, France, and Spain all rose 0.6%, 1.3%, and 1%, respectively.