Bridging Troubled Markets
• Weighing the impact of monetary policy tightening efforts and its impact on market emotions
• Discussion of the primary dislocations in the market economy and their impact on inflation
• Gauging the strength of the continuing post-COVID pandemic economic reopening and its capacity to offset recession concerns
Just as we were kicking off the Memorial Day weekend, a last-minute market burst provided investors with long-needed relief as the S&P 500 broke its losing streak of seven consecutive weeks. At the week’s close, some encouraging retailer earnings, mixed economic data, and easing concerns of an overly aggressive monetary tightening through year-end delivered enough encouragement to affect the market positively. Although it is still too soon to move May firmly into the positive column, the uptick of 6.5% during this past week (May 23-27) was a welcome reprieve from recent bearish economic, consumer, and central bank
Not surprisingly, investors have remained excessively skittish over the past several months. Despite this past week’s market bounce, the major global indexes are still in correction (or bear market) territory, falling 10% to 20% this year alone. The accompanying chart demonstrates that investors found few hiding places.
With the exception of utilities and energy, all sectors are posting negative returns for the year. Overseas markets are in the same boat. Gold, up slightly, has provided some stability, but it is certainly not a source of returns. The other safe harbor, fixed income, has also reminded investors that when rates rise, bond prices fall. One safe haven not highlighted is agricultural commodities. Although few investors hold stakes in wheat futures, they are all impacted by rising grain prices.
Market and consumer reactions over the past several months may have seemed extreme at times, but it’s valuable to point out how quickly the economic backdrop has changed since late last year. On November 8, 2021, a few Federal Reserve officials began the process of “talking up” interest rates, despite the uncertainty of the timing, even among themselves. Federal Reserve Vice Chairman Richard Clarida noted that the criteria for a rate hike could be met before the end of 2022, adding that “most of the inflation will prove to be transitory.” St. Louis Federal Reserve Bank President James Bullard, on the other hand, took a more hawkish tone, holding out the possibility of two rate hikes in 2022. Neither Fed member’s comments proved to be prophetic of the path monetary policy would soon take.
Fast forward to the present: Two fed funds rate hikes have already taken effect—the first, a quarter-percent increase on March 16, and the second, a one-half percent increase on May 4. Parenthetically, the latter rate hike represents the highest increase in 22 years. Also included in the rate increase announced in May were plans to begin reducing balance sheet assets by as much as $47.5 billion each month beginning on June 1 and as much as $95 billion per month starting in September. Suddenly, the liquidity forces that swiftly calmed the markets during the early days of the pandemic in 2020 were just as quickly being dismantled. The impact of reducing the $8.91 trillion in balance sheet assets held by the Fed (up from $4.1 trillion on February 24, 2020), coupled with rising rates, was unnerving the markets.
In addition to the Federal Reserve monetary policy tightening—or more specifically, contributing to its acceleration—is the ever escalating overseas fighting in Ukraine. Adding to the economic and human tolls of the Russian and Ukraine war, escalating costs associated with curtailed oil and food shipments are now creating shortages and dramatic price increases here and overseas. With most global markets embargoing Russian exports, grain and energy prices are rising. European countries, dependent on Russia for 40% of their natural gas and 28% of their oil imports, are now scrambling for alternate sources. Global food markets are likewise affected with consumers overly dependent on the Russian and Ukrainian farm belts. Today, these two markets, each ranked in the top five global exporters of wheat, barley, rye, corn, and sunflowers, are completely off-line. With current and future food commodity shortages exacerbated, prices are surging. As just two examples, wheat prices are up 37% year-to-date and corn is up 21%.
Likewise, energy supplies and prices are affected. The embargo on Russian goods has furthered a global demand-fueled shortage. Here in the U.S., spiking Brent crude oil prices registering $120/barrel over the Memorial Day weekend, pushed gasoline prices to $4.61 per gallon (versus $3.04 per gallon one year ago). Natural gas prices (Henry Hub) rose above $9 per million British thermal units (MMBtu) for the first time since 2008.
The impact of these price surges and increasing interest rates has contributed to this year’s market volatility and most certainly a bit of the economic turmoil. A sampling of recent press headlines also helps define the mood swings in consumer and investor sentiment.
• Eighty-one percent of Americans believe the U.S. will experience recession this year.
Microsoft News, 4/4/22
• Wall Street in turmoil amid inflation, recession fears.
Microsoft News, 4/27/22
• Goldman Sachs official tells ‘Face the Nation’ the risk of recession is very, very high.
Fox News, 5/17/22
• For markets, inflation fears are joined by recession risks.
Financial Times, 5/22/22
• Optimism Below 20% for Fourth Time in Seven Weeks.
AAII Sentiment Survey, 5/26/22
• Fed survey: 57% of respondents say Fed efforts will cause recession.
Pricing in Recession
Looking at a mountain of data over the Memorial Day weekend, it’s reasonably clear that the markets have already priced in a recession, despite last week’s performance claw-back. Recent GDP revisions also helped push the recent first quarter’s growth rate further into negative range (-1.5%). Weights on the national growth rate this past quarter continue to include the lagging impact of pandemic-related supply chain and employment disruptions coupled with declining government expenditures, specifically the expiration of pandemic assistance payments. Also telling is a jump in the Consumer Price Index to an 8.3% inflation level and weakened data from May’s Empire Manufacturing Index, Philly’s Manufacturing Survey, and the University of Michigan’s Consumer Confidence Survey—indications of the loss in economic momentum over the past few months.
A question on the minds of many is how far ahead the current inflation readings are “baked” into the economy. Is this a one-quarter phenomenon or do rising costs, labor shortages, trade imbalances, and declining corporate profits carry the negative growth rate into the second quarter scorecard? As is usually the case, the data is mixed. Although consumers are negative in their view of the economy, they tend to be less pessimistic about their personal finances, their future personal situation, and expectations. Retail sales remain strong with total sales up 67% from COVID lows and 29% above pre-COVID highs, while the April Personal Incomes and Outlays report highlighted better-than-expected consumer spending. And although the housing markets are suffering from higher mortgage rates (30-year note at 5.24%) and higher prices (April’s median sales price of $450,600, according to the St. Louis Fed), homeowner vacancy rates are at their lowest level since 1956, according to Renaissance Macro Research. In addition, inventory levels remain tight, declining 12.1% from a year earlier to the current level of 409,473 available houses.
Meanwhile, underlying economic strengths remain in play. Supply chain recalibration is helping bring down supply-constrained inflationary pressures, and airport traffic flows are back to pre-pandemic levels. The strengthening dollar has helped curtail import price inflation, and the job market still remains positive, courtesy of continuing near-historic low unemployment levels (3.6%) and increased job openings. One interesting data point, however, is the uptick in initial unemployment claims. This trend was most likely a result of the rush to hire to meet the initial reopening surge. It is sure to be followed closely by Fed policymakers as employers begin rationalizing staffing needs with real customer demand and squeezed profit margins.
Numerous signals have also emerged recently indicating that we have already hit “peak inflation” and “peak Fed hawkishness” as both CPI and Core PEC Price Index signal a tipping point. Ultimately, the Fed’s goal is to slow down economic growth and inflation levels. Key questions to determine if we are still trending toward a bear market or a rebound are how much the economy will slow and how quickly inflation will decline.
Although this year’s first quarter certainly provided the markets a recession scare, today’s data has not been convincing enough to project the downturn continuing into this second quarter—yet. Nor has the data indicated future inflation levels further escalating out of control. Forecasts from both the Atlanta and St. Louis Fed’s GDPNow models are more optimistic, with the next quarter expected to register a positive, annualized 1.9% growth rate. Consumers are somewhat more optimistic about the future levels of inflation as well, expecting levels to fall toward more normal level of 2.3% over the next five years.
On the manufacturing and services front, U.S companies are still on a stable footing. Despite a downtick in April’s ISM Manufacturing Index, recent data continues to point to the 23rd consecutive month of expansion. Of note for both manufacturing and services, seventeen industries reported orders growth in April, while five of those six largest manufacturing industries reported moderate to strong growth through April. Also reaffirming the recession-bucking trend was data that showed industrial production and capital utilization rates are now back within 0.5% of their longer-term averages. Much of the boost came from increased activity in the auto, defense equipment, business, and space equipment manufacturing industries.
It is much too early to predict whether or not the Federal Reserve will cut short its tightening regime. Fed Chair Powell has set his target on reducing inflation to a 2% goal to maintain price and labor market stability without a recession. That is no easy task, but we think the Fed’s tightening schedule is now more dependent on the trajectory of economic activity.
Factors that should provide some footing for a recovery are the current job markets (tight but adjusting to staffing needs); continued growth in consumer spending; the underlying strength in both the manufacturing and services industries; the elimination of supply-chain bottlenecks and the resumption of trade; normalcy in travel; continuing transparency in corporate earnings growth trends; and the continued opening of economies post-COVID. That is a tall order considering the need to wind down the Fed’s hawkish rhetoric (which might have been necessary last summer or early fall), a meaningful rollover in inflationary pressures (which may have peaked earlier this month), and perhaps the most difficult, a meaningful resolution in the conflict between Russia and Ukraine.
Not Investment Advice or an Offer -This information is intended to assist investors. The information does not constitute investment advice or an offer to invest or to provide management services. It is not our intention to state, indicate, or imply in any manner that current or past results are indicative of future results or expectations. As with all investments, there are associated risks and you could lose money investing. Argent Financial Group is the parent company of Argent Trust, Heritage Trust and AmeriTrust.