Gill Capital Partners Fourth of July 2022 Update
Happy Fourth of July to all of our friends, clients and partners. We hope you are all able to take some time to celebrate this holiday. Speaking of celebrating, we wanted to congratulate the Colorado Avalanche for winning the Stanley Cup. With the University of Denver winning the NCAA Men’s hockey championship, this marks the first time since 1972, when the Boston Bruins and Boston University did it, that both professional and collegiate hockey teams reside in the same city.
There is plenty going on in the world of economics and financial markets, including updates on the inflation front and our current view on the markets. We will get into all of that and more, but first, below are a few interesting facts about the Fourth of July:
Only two men signed the Declaration of Independence on July 4, 1776 (Charles Thompson & John Hancock). The other 54 delegates signed over the course of the next month.
The average age of the signers was 45 years old. With the youngest signer, Edward Rutledge of South Carolina, coming in at only 26. The oldest signer was none other than Benjamin Franklin, who was 70.
Thomas Jefferson, 82, and John Adams, 90, both died on July 4, 1826 within five hours of each other on the 50th anniversary of the signing of the Declaration of Independence
Inflation Updates
Inflation is the focus of all markets at the moment. A disappointing read on inflation earlier this month drove the Federal Reserve to an even more aggressive rate hike of 0.75% than expected and the same price for July. Understanding the likely path of inflation is paramount to understanding where we are in this cycle and where interest rates and equities may go next. So, where are we? A couple of interesting observations on inflation. First, input prices for most commodities are collapsing. As shown in the chart below, most commodity prices have dropped in June, some dramatically.
The two most important contributors to overall inflation (CPI) are oil and natural gas. Oil, while currently below its peak, is remaining stubbornly high above $100/barrel. Natural gas has come down materially over the past month, retreating nearly 30% from its peak in early June.
Our view – We remain cautiously optimistic that the severe inflationary pressures from the past six months will begin to subside in the latter half of this year. As shown above, input prices for many commodities are coming down, which is good news on the inflation front. Inflation numbers have begun to decouple from underlying commodity prices, and we therefore, anticipate inflationary data to begin coming down shortly. It takes time for input prices to work their way through to finished goods, but we can see relief coming. Oil is another story and a very important one. Energy is currently the single largest contributor to inflation and is very damaging to overall economic growth at these levels. While we are seeing natural gas move much lower, oil remains stubbornly high. We are watching the price of oil very closely these days. We will get another look at inflation with the monthly CPI report on July 13, a very important report for the markets.
Market & Economic Updates
As of this writing, U.S. equity markets remain in a bear market with the S&P 500 down a little over 20% and the NASDAQ down over 30%. Bond markets have also struggled (Barclays Agg. Bond Index down over 10%) as interest rates have risen dramatically. Both equities and bonds have been hit by a nasty cocktail of high inflation, an aggressive Federal Reserve (both increasing interest rates and shrinking its balance sheet), pandemic related labor and supply chain hangover, and an increasingly hostile geopolitical backdrop. On the economic front, the drop in Q1 GDP was slightly larger than previously thought, as it was revised downward a bit further to -1.6% from -1.5%. A reduction in consumer spending was the main culprit, as inflationary pressures hit consumers hard. Recessionary rumblings have been increasing as data continues to confirm a slowing economic picture.
Our view – Ok, first for the bad news, and yes, there will be some good news. The data has continued to erode from an economic perspective, and so too has the likelihood of a recession. Let’s discuss the recession. We agree that recent data suggests that the odds of a recession are increasing. In fact, we feel there is a decent chance that when the data comes out in a couple of months, it very well may show that we are in a recession now. Recessions are a natural part of the economic cycle, They are unavoidable and often occur simultaneously with bear markets. So why are we beginning to feel a bit more optimistic? A couple of reasons. First, we know that equity markets usually bottom before recessions are actually reported, as economic data is backward looking and delayed. As shown in the chart below, equity markets have historically started rising by the time the recession was underway.
Secondly, looking at previous bear markets, the average duration is about 9.6 months, with the typical market drawdown of about 36%. We are already six months into the current bear market, and so while it may not be over, we are well on our way. Economic data, including GDP reports are backward looking, stale data. We are watching real time indicators that might give us clues as to potential turning points in equity markets. Below are a few significant indicators we are watching:
Inflation – This is the biggie, monthly GDP is also stale, but we can begin to gauge real time inflation by looking at commodity prices. We are seeing many components of inflation begin to move in the right direction.
Interest Rates – In past cycles, equity markets did not bottom until long term Treasury yields were declining or had peaked. In the last three cycles, bond yields started falling well before the equity bottom. Barring continued bad inflation data, we think there is a decent chance that rates may have peaked.
Investor Sentiment – Past market bottoms have been marked by extremely negative sentiment. Consumer Sentiment is the lowest in history (good for a market bottom), as the percentage of stocks trading below their cash value is at the highest level we have seen in 40+ years, telling us that investors have capitulated in certain parts of the market.
In conclusion, while we are not out of the woods yet, and economic data is likely to deteriorate further, markets generally bottom well before the economy does, and a lot of bad news has already been priced into this market. Keep your seatbelts on, and we hope you all have a celebratory and safe Fourth of July holiday.
As always, please let us know if you have any questions or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.