Gill Capital Partners Mid-Summer 2022 Update
The summer months are generally relatively quiet for the financial markets. This year, however, has been the exception. There has been no shortage of financial headlines, including news of a technical recession, another Federal Reserve rate hike, and continued high inflation. Despite these headlines, stocks are quietly having their best month since November of 2020. We will get into that, but first, an interesting commentary from the Wall Street Journal: the $1.50 Costco hot dog combo that defies inflation.
The price for a hot dog and a soda combo at Costco is $1.50, which has remained unchanged since its debut in 1985.
If the price of the hot dog combo kept up with the rate of inflation, it would cost about $4.13 today.
Costco is almost certainly losing money by selling the combo at this price, but according to management, price hikes will never be on the table for this cult-like offering.
Recession Update
Okay, first the bad news. It was reported this week that the U.S. economy shrank again in the second quarter of 2022, contracting 0.9%. The standard definition of a recession is two consecutive quarters of negative GDP. Though economists are mixed on whether we are officially in a recession, if you follow this common definition, we are, and have been for a few months. To be clear, it is not officially considered a recession until the National Bureau of Economic Research makes the determination, but really, this is a matter of semantics.
Our view – As we mentioned last month, based on the economic data, it was looking ever more likely that this was the case. However, don’t let the term recession scare you; this is a natural part of the economic cycle, and the stock market had been forecasting slower growth for many months. From our perspective, it matters less what you call it, technically or otherwise, and more that we understand what the scope and breadth of this economic slowdown will look like. The Federal Reserve has been trying to cool the economy from an overheated post-COVID high, and it is working. We will discuss this in more detail below, but markets have regained confidence in the Federal Reserve, equity prices have adjusted rapidly to reduced earnings expectations, and inflation is poised to moderate in the second half of the year. Due to the slowing economy, many analysts and investors believe the Federal Reserve may take their foot off the interest rate pedal sooner than originally anticipated. This is good news for stocks and bonds, and the main reason why markets are now rallying.
Federal Reserve, Inflation, and Interest Rates
The Federal Reserve hiked rates by another 75 basis points this month, in a move that was widely anticipated and priced into interest rate curves. This was the second move of this size, and the two rate hikes have been the most aggressive since the early 1990s. This month’s hike was in response to another hot inflation report from June that showed inflation increasing by over 9% on a year-over-year basis.
Our view – Sometimes, bad news is good news. Remember, the economic data is backward looking, and markets are looking forward. Why did stocks and bonds rally on the news of aggressive Fed tightening, and what does this all mean?
Markets have already priced in this most recent rate hike, and another 1% on top of that.
Due to the very real economic slowing (recession), markets are now becoming confident that interest rates have likely priced in the worst-case scenario and are beginning to price in rates leveling off.
With oil prices and many other commodities well off their June peaks and signs that the housing market is slowing, markets are becoming more confident that inflation may have peaked.
With so much bad news already priced in, markets are feeling a bit more confident about the likely path of interest rates and inflation. Interest rates on bonds have been coming down over the past 30 days due to the dynamics outlined above. As of this writing, the yield on the 10-year U.S. Treasury currently sits at 2.65%, down from nearly 3.5% on June 15th. That is a significant move in a short period of time. Barring surprises on the inflation front in the coming months, we believe it is becoming increasingly likely that we have seen the peak in interest rates for many fixed income securities for the time being.
Stock Market Update
As of this writing, the S&P 500 is up nearly 8% during the month of July, which is its best monthly performance since November of 2020. Stocks remain well into the red for the year, but investors are feeling more optimistic.
Our view – The areas of the market that saw the most pressure earlier this year, such as technology and healthcare, are now leading the market higher. These are some of the most economically and interest rate-sensitive sectors that are once again appearing attractive in light of lower yields. On another positive note, Q2 earnings season is underway and, so far, technology earnings have been a strong, with big tech posting primarily upside surprises.
We are not out of the woods yet, and economic data is likely to deteriorate further, but it is important to remember that markets generally bottom well before the economy. Plenty of bad news has already been priced into this market.
Enjoy the rest of your summer, and if high prices have you feeling overwhelmed, head over to Costco for a $1.50 hot dog and soda.
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.