July 31, 2022
Weekly Market Outlook
By Keith Schneider and Donn Goodman
It was a good week and an exceptionally good month in the markets.
The S&P 500 was up 9.1%. This was the best July since 1939. Conversely, it came on the heels of the 3rd worst June ever, down 8.4%.
We have continually illuminated for you that the market is made up of three important inputs. A change, positive or negative in any of these inputs, can result in the market rallying or taking a nosedive. These inputs are inflation, interest rates, and earnings. Let’s see what might have fueled this recent relief rally:
Ending in June, energy costs rose 43% for the past 12 months.
Food costs in June showed a rise of 10% for the past 12 months.
Grocery store costs in June showed a rise of 12% for the past 12 months.
However, energy and some commodities have come down, which served as a near-term positive for the stock market. Certainly, Friday’s market action was not disturbed by these very high numbers.
This has clearly been the surprise recently especially given the Federal Reserve raising their key lending rate this past week by 75 basis points. After hitting 3.09% in early July, the 10-year US Treasury rate came down to 2.67% this week. TLT (20-year bond funds MarketGauge frequently uses) have rallied from 112 to 117 at the end of the month.
The rise in long-term rates reflects increased concern over future economic weakness, which was verified by the contraction of quarterly GDP numbers announced this past week. Many economists are forecasting a recession on the horizon (if not already… which is currently being debated).
High Yield bonds (junk), an often-used proxy for risk on assets, had the best month (up 5.1%) since October 2011. See charts below:
Until we see a decline/contraction in earnings across the board, the economic weakness caused by rising Fed borrowing costs and higher inflation may be muted.
Last week (and throughout July), we told you our indicators were improving and that we had entered Risk On in several of our algo based investment strategies. In our coaching and certainly Mish’s recent appearances on National TV, we pointed to our indicators suggesting we were in for a mean reversion trade.
We were, at worst neutral on certain sectors and, at best, urging your attention to areas such as Consumer Discretionary and Technology. Here are a few of Mish’s recent TV appearances which echo the more positive sentiment. (Remember that we told you she had suggested purchasing ARKK a few weeks back - a bold forecast that the market could and would go into a Risk On rally mode).
Mish Talks Macro with David Keller
Big Tech Earnings and the Impact
FOMC Market Reaction and the Macro
A Tale of Different Cities.
Due to a family situation, I found myself in Phoenix this past week. Here is a city that is being overrun with new residents. Today they announced occupancy of commercial buildings at just 2.6%; basically “full up.” They cite the migration of new residents pouring into the city and that there are 80,000+ new workers in the area over the past 12 months. Inflation in Pheonix is running the hottest in the US at 20%+ year-over-year. Rentals of apartments on average, went from $1500 a month to $2,300 a month. Housing prices increased by 23% YoY. Sales of resale homes are still taking less than a week, but there are no longer 5 bids over asking price. Still, this is quite different than Cleveland, where I live.
Cleveland, like much of the Midwest is seeing an abrupt slowdown. Apartment occupancies are starting to rise, and there is not much of a rate increase for the moment. Home sales have basically stopped as Cleveland and much of the area is much more dependent on mortgages which have risen from 3% (on a 30 year) to over 6%, a 100% increase in 8 months. Moreover, we are starting to see retail establishments and restaurants slow as people have to decide if they get gas or go out to dinner.
Interestingly, both cities share one distinct problem. Small businesses and restaurants are closing their doors as their landlords are raising rents putting them in a no-win situation of moving or closing down. In Cleveland, we see the latter.
News this past week in Phoenix also reported several long-standing businesses that have had to close their doors (after many decades in business). We suspect there will be more. It will be interesting to see how tourism in Arizona fares this coming winter. While the Super Bowl is being held there (yet again), there are rumors that some of the business conferences are canceling.
Looking Under the Surface
Here are a few more important economic indicators that convey to us that we should expect more volatility and a retest of the lower range on the markets in the next few months:
Consumer Confidence. Trending downward.
17% of consumers said business conditions were “good,” down from 19.5%
24% of consumers said business conditions were “bad,” up from 22.8%
50.1% of consumers said jobs were “plentiful,” down from 51.5%
12.3% of consumers said jobs were “hard to get,” up from 11.6%
Leading Economic Index (LEI)
The LEI is a weighted average of 10 indicators designed to show whether the economy is getting better or worse.
The leading economic index fell 0.8% in June, the US Conference Board said Thursday. Economists polled by The Wall Street Journal expected a 0.6% decline. This is the fourth straight monthly decline. Consumer pessimism about the outlook drove the index down along with falling stock prices (thru June), moderating labor market conditions, and weak orders for manufacturers.
Other Economic Signals
Fortunately, and certainly reflective of the market’s newfound momentum this past month, have been several important economic indicators with little change. These include Advanced Durable Goods Orders, Semiconductor Chip orders, and Advance International Trade Orders, all mostly flat to slight increases. However, two other areas are worrisome for economists and show significant weakness midway through 2022. See charts below:
Bad is Good, Good is Bad
As we have pointed out here (many times), bad news is now being construed as “good” for the markets. Weakness in economic numbers this soon in the Fed tightening cycle (and clearly because of much higher consumer prices) implies that the economy is slowing down. To an economist, this means that: 1) Fed action is already working; 2) higher prices are causing a natural demand destruction cycle, and most importantly; 3) The Fed may not have to remain hawkish, and this could lead to a “pause” in the hiking cycle. We have seen this as interest rates have come down quickly in the past few weeks.
Chicago PMI
More bad news. Given how negative the PCE and LEI numbers were (see above), Friday morning, the Chicago Purchasing Manager index came out weak, adding to data demonstrating how bad the economic numbers continue to be. Production hit a 2-year low and new orders hit a 25-month low. These indicators are clearly showing that we are headed for a recession if we are not already in one!
August Seasonality and Midterm Years:
As you will see on the charts below, July typically is one of the better investing months in the stock market. This past month was no exception. However, August can be a different story.
Investors taking a vacation, portfolio managers getting away, lighter volume, and not as many earnings reports all contribute to August’s muted historical gains. As you will see, the NASDAQ (Tech heavier index) does a bit better.
Factor in additional influence from midterm election years, and August does not typically do well (nor does the next few months until the election is over). The confusion of who will be in charge in Congress, the heated rhetoric of one party telling you how poorly the other party is doing to attract votes, and confusion on the state of the economy all contribute to this period’s poor performance. Add high inflation, uncertain interest rates, and disappointing earnings, and you can have a recipe for enhanced volatility. It appears that much of the historical midterm market behavior is playing out closely. See the midterm chart below:
What Now?
We highly recommend that you put these suggestions into your financial game plan for the immediate future:
Here are this week’s Big View summary points taken from our all-important Friday afternoon Investment Committee (IC) meeting.
Risk On
Risk Off
Neutral
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