Throughout my interactions with many of you over the past three to four months, I have heard the following regarding how you are feeling about the markets so far this year: “frustrated”, “scared”, “nervous”, “trying to remain patient”, and “when is this going to end?” This extreme range of emotions is not going unheard by me, and I understand where you’re coming from.
We all know how difficult the markets have performed over the first six months of the year, as reflected in your monthly statements. I know several of you have not looked at your month end statements out of fear of seeing what you have lost on paper. I must admit, I have not looked at my own either.
The S&P 500 was trading in bear market territory (a 20% decline) for around 10-days in June. It is common for a bear market to occur twice in any given decade. Since that low point in June, the S&P 500 recovered nearly 9.00%, which is a significant recovery in a short period of time. If it stays on this course, your July month end statement will show a positive return, which I know will be a breath of fresh air for you. Only time will tell if this trend continues or if the market reverses itself.
There is no need to revisit in detail how we got to this point, which includes factors such as inflation, interest rates, government stimulus, and recession, to name a few.
However, I do want to share with you what I believe needs to start to happen in five tracked economic areas for a more consistent upward trend in the markets and your portfolios.
Interest Rates and Inflation:
As I have mentioned in past commentaries, these two economic factors are very much intertwined. As the Federal Reserve continues to tighten the money supply by raising interest rates to reduce inflation, (which is at a 40-year high,) the markets are starting to price in future rate increases and adjust to this policy. Last month, core inflation actually declined despite the continued inflationary increases in energy and food prices. It is my feeling that we may start to see a decline in inflation by the end of the third quarter due to the Federal Reserve’s aggressive policy. If this does occur, I would anticipate the markets to start seeing an end to the tightening policy, which could very well move the markets up.
Commodity Prices:
This index, which includes oil, is very volatile and is also vital to the manufacturing sector in this country. We have all been directly impacted by this every time we fill up our gas tank. Prior to the end of June, the price of gas in the Los Angeles area ranged between $6.50 to $7.00 a gallon. Since June 8th, the price of the OIL exchange traded fund, which tracks the price of oil, is down nearly 20%. This is a significant decline that is putting more money in the consumer’s pocketbook at the gas pump. I have now seen a gallon of gas as low at $5.40. I know gas prices are still higher than we would like them to be, but if this trend continues, the markets should embrace further gains.
Jobs, Consumer Spending and Consumer Confidence:
Much like interest rates and inflation, these three are very much tied together. Even though there has been recent news that such employers as Apple, Microsoft and Alphabet/Google have announced short-term hiring freezes, job growth remains very strong. In fact, the level of jobs being created is greater than the pre-Pandemic level and employers are creating more jobs than there are workers. This is very frustrating for employers, as consumer demand continues at a steady pace. Consumer spending, which makes up 70% of GDP, continues to be solid. As long as people have jobs, they will continue to spend, which will drive the economy forward. Regarding consumer confidence (which can change month by month), is showing some recent decline. Nonetheless, if people are employed, they will spend money. When inflation starts to decline, along with grocery and gas prices, consumers will have more money to spend.
Fears of A Recession:
I cannot tell you how many articles or interviews I have read or heard on this topic with opinions differing greatly as to if, when, and how long a recession will occur. Many are blaming the Federal Reserves and the Treasury Secretary for missing the mark on this, and rightly so, since they both thought inflation was going to be transitory. Ironically, the consumer participated in driving up inflation because, as the economy started to open and the supply chains were clogged, the consumer kept spending. Inflation must be addressed first and foremost. Even though there are those that believe a recession is when the economy has back-to-back negative growth in GDP, probably the strongest indicator of a recession is reduction in the work force due to layoffs, which, as mentioned above, is not happening. A freeze on job creation is not a contraction of the work force. Any small business owner knows that payroll is their largest expense. If a recession was imminent, they would start laying off workers. Another reason I do not believe we are in a recession is that business investment is also improving as businesses find new ways to innovate the manufacturing to improve their productivity and margins. There is nothing to me that states we are in a recession, and if one were to occur, I would not expect it until sometime in 2023.
Earnings:
As of July 21st, around 21% of S&P 500 companies had reported earnings so far. Of that number, 74% have exceeded their earnings estimates, and 3% have matched earnings estimates. The five-year historical average is 77% for companies to exceed their quarterly earnings. Historically speaking, and with only around 21% of earnings reported so far, earnings are nearly in-line with expectations. So far, it has been only the financial sector, which represents between 10% to 12% of the S&P 500, that has reported earnings of 58% below their target. It is too early in the earning season to say that earnings have not exceeded the historical average because as of a week ago, the percentage of those companies that had exceeded earnings was around 67%. In a one-week period, the average has increased, which is a positive sign. Corporate guidance going forward is “being held close to the vest” as companies continue to manage analysts’ expectations during this high inflationary period and a possible recession.
Final Comments:
- Unlike in 2018 and 2022 when the market bottomed out and then advanced at almost a 45% upward angle, this bottom continues to be volatile.
- There will be headwinds going forward but the strength of these headwinds will be dependent on how a number of the aforementioned factors fair.
- As you know from past email communications, I reduced the stock/equity positions in your portfolio earlier during the year. Recently, I added in short-term laddered FDIC CDs, and raised cash to record levels relative to past levels into your portfolio. This was done to provide greater downside protection for you, as the market tries to stabilize before advancing again.
- Each period of extreme market volatility and even bear markets have their own personality—some more severe than others. This period is not uncommon and, as in the past, we will get through it. They key is to remain patient and maintain your time horizon over the long term.
- Finally, ask yourself if you feel as though things are getting worse or better from where we have been. I believe we are slowly starting to turn the corner, but there will be headwinds to maneuver; hence the need to stay a little more cautious and defensive for the near term.
Feel free to reach out to me if you have any questions regarding my commentary.
Enjoy the rest of your summer with your family and friends.