By Ben Norris, CFA, Securities Research Analyst, Associate Vice President
0.75% and -0.9%. These were arguably the two most consequential numbers for markets last week. On Wednesday the Fed, the Federal Open Market Committee (FOMC) to be precise, announced that a .75% increase in the target Fed funds rate to 2.25-2.50%. The Fed has been the star of the financial markets show for the better part of the last 12 months. It appears they will remain at center stage until price pressures come under control or the U.S. economy is tipped into a recession – or both. Two weeks ago, inflation figures once again came in higher than expectations which led some to speculate that the Fed might pursue a more aggressive path toward raising rates. CME Group’s FedWatch Tool saw expectations for a 1.0% hike shoot briefly higher before Fed officials were forced to communicate that they would almost certainly go with the 0.75% move that they’ve been hinting at since the last FOMC meeting.
After the FOMC concluded its meeting with a press conference on Wednesday, the first reading of Q2 U.S. GDP was released on Thursday morning. Calling the data a disappointment would be generous. The consensus expectation was for Q2 GDP to grow by 0.3-0.4%, but reality bites and the American economy shrunk at an annual rate of -0.9% in the quarter. This figure is concerning because GDP growth was negative in Q1 of this year as well. The traditional view is that if GDP contracts for two consecutive quarters, then the economy is in a recession. This was the first reading of GDP, and the figure could get revised higher, but the likelihood that it will tilt back into positive territory feels unlikely. The largest detractor to GDP in Q2 was inventories which brought down the overall number by 2.0%. Without the headwind created by inventory drawdowns, GDP would have positive. Net exports and consumer spending were positive contributors as the U.S. economy is on a faster pace toward recovery relative to the rest of the world following pandemic lockdowns.
While tradition says we’re in a recession, economists at the non-partisan National Bureau of Economic Research (NBER) have the final say on officially declaring recessions. The NBER takes a more holistic view than just looking at two quarters of GDP, considering other factors such as employment and industrial activity. The NBER’s definition of a recession is a “significant decline in economic activity that spreads across the economy and that lasts more than a few months.” This definition allows for some flexibility when declaring an official recession. At this time, the NBER feels that the economy has not slowed sufficiently to make that call. Imaginary recession or not, the latest GDP and inflation figures make it clear that the U.S. is experiencing stagflation – a possibility we highlighted in May. Stagflation occurs when an economy experiences slow or negative economic growth and high inflation simultaneously. So while we have to wait for what looks like an inevitable recession to be declared we don’t have to wait for the pain of high inflation.
Despite all the negative news around inflation and economic growth, investors found reasons to buy up stocks last week – July was the best month for stock market returns since November 2020. Some of the strong performance, especially Friday’s rally, could be attributed to investors expecting the Fed to take their foot off the brakes a bit after Thursday’s GDP reading. It’s clear that the economy is slowing, and many believe that price pressures should follow in short order. Fed Chairman Jerome Powell took on a less hawkish tone in his Thursday press conference. Another factor in last week’s rally was better than expected corporate earnings, especially in the influential Information Technology sector. When earnings have been short of expectations, many management and investor relations teams have reassured investors that their longer-term outlook for business conditions remains mostly strong. Still, the consensus expectations for S&P 500 earnings growth in Q2 is for mid-single digits growth vs. Q2 2021. However, without the Energy sector, which is seeing record profits thanks to high crude oil prices, earnings expectations would be negative.
The S&P 500 (SPX) saw a gain of 9.2% in July while the Technology sector heavy NASDAQ Composite (COMP) saw a gain of 12.3%. SPX and COMP are still down 12.6% and 20.8% respectively for the year. Investors are now asking themselves, have we seen the worst of this bear market or is this a short-term bounce before we continue a move lower? Many factors that will influence whether the next move is higher or lower. I would like to note a few things and let you decide for yourself.
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- Earnings could continue to come in better than expected. American companies are generally in better shape than their global counterparts and that could mean that earnings surprise to the upside.
- The Fed made the decision to hike rates based on data from April to June. Their path forward could be less aggressive than previously expected given the latest GDP reading.
- Many economic indicators, such as employment, consumption, and manufacturing activity remain fairly strong. These factors argue against a serious economic slowdown in the near term.
- Inflation remains stubbornly high and predictions for a peak have so far been premature.
This week’s slate of economic data is light compared to last week’s full slate. Monday will bring construction and manufacturing data. Later in the week we’ll see a variety of employment data which will be important for the recession debate. Finally, a few Federal Reserve speakers may give hints at the next steps policy steps from the FOMC.
| Date | Report |
Previous |
Consensus |
| Monday 8/1/2022 | ISM Manufacturing Index (July) |
53.0 |
52.1 |
| Construction Spending (May) |
-0.1% |
0.4% |
|
| Tuesday 8/2/2022 | Job Openings (June) |
11.3M |
11.0M |
| Job Quits (June) |
4.3M |
— |
|
| Real Household Debt |
0.0% |
— |
|
| Wednesday 8/3/2022 | ISM Services Index (July) |
47.0 |
47.5 |
| Factory Orders (June) |
1.6% |
1.0% |
|
| Thursday 8/4/2022 | Initial Jobless Claims (July 30) |
256,000 |
255,000 |
| Continuing Jobless Claims (July 23) |
1.36M |
— |
|
| Trade Deficit (June) |
-$85.5B |
-$79.6B |
|
| Friday 8/5/2022 | Unemployment Rate |
3.6% |
3.6% |
| Labor Force Participation Rate |
82.3% |
— |
Links to previously published commentaries can be found at benjaminfedwards.com/Investment Planning/Educational Resources/Market.