August 2022
US Economy: Recession?
U.S. GDP shrank for the 2nd consecutive quarter (-0.9% in Q2) marking a “technical” recession as rising food and energy prices continue to drive rapid inflation (9.1% annualized per latest CPI). However, broader economic data complicates the picture, with a healthy U.S. job market, growth in inflation-adjusted consumer spending and manufacturing.
US Stocks: Relief rally.
July was the best month for U.S. stocks since Q2 2020, as 73% of S&P 500 companies beat analysts’ meager 2nd quarter earnings expectations. Investors also interpreted the negative U.S. GDP result to mean the Fed would not need to hike rates as aggressively. Generally, cyclical small-cap stocks and growth stocks sensitive to interest rates outperformed.
Foreign Stocks: Eurozone strength.
Despite ongoing war in Eastern Europe and political stressors (dissolution of the Italian parliament, etc.), the regional economy expanded 0.7% in Q2, with Swedish (+11.3%) and Irish (+10.7%) markets in the lead. Japan (+5.6%) rose on a stronger yen and stimulus, while China (-9.7%) dragged down emerging markets as anticipated economic stimulus failed to materialize.
Fixed Income: Fed hikes, rates fall.
The Fed raised its target interest rate another 75 basis points, but the yield on 10-year US Treasuries fell 30 basis points (to 2.7% from 3.0%). Bond investors seem to believe inflation will cool and risks are skewed toward recession. Counterintuitively, high-yield bonds performed well, despite recession fears, with investors seeing value in low defaults and yields nearing 8%.
Real Assets: Commodity rebound.
Commodities bounced back from recession fears, as an anticipated drop in Russian natural gas exports to the EU and unseasonably warm weather drove up energy prices. Other corners within real assets also performed well, with REITs aided by both ongoing inflation concerns and expectations that interest rates may rise less dramatically.
Alternatives: Pricing lag.
Some private investments appear to have weathered the 2022 storm exceedingly well. However, that may be somewhat due to the limited number of market transactions, which make it difficult to assess recent valuations. Private funds are traditionally slow to mark down investments but that is a phenomenon that typically does not persist as transactions increase.
Equities Total Return
| JUL | YTD | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | 9.2% | (12.6%) | (5.1%) |
| U.S. Small Cap | 10.4% | (15.5%) | (14.9%) |
| U.S. Growth | 12.0% | (19.6%) | (13.3%) |
| U.S. Value | 6.8% | (7.2%) | (2.1%) |
| Int’l Developed | 5.0% | (15.6%) | (15.1%) |
| Emerging Markets | (0.2%) | (17.8%) | (21.2%) |
Fixed Income Total Return
| JUL | YTD | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | 2.4% | (8.2%) | (9.0%) |
| TIPS | 4.4% | (5.0%) | (3.4%) |
| U.S. High Yield | 6.0% | (8.9%) | (7.7%) |
| Int’l Developed | 2.6% | (6.5%) | (7.9%) |
| Emerging Markets | 1.4% | (2.2%) | (1.9%) |
| Tax-Exempt | |||
| Intermediate Munis | 1.9% | (3.9%) | (4.5%) |
| Munis Broad Mkt | 2.7% | (6.8%) | (7.1%) |
Non-Traditional Assets Total Return
| JUL | YTD | 1 YR | |
|---|---|---|---|
| Commodities | 4.3% | 23.5% | 25.6% |
| REITs | 9.1% | (13.0%) | (2.2%) |
| Infrastructure | 4.0% | 3.5% | 7.7% |
| Hedge Funds | |||
| Absolute Return | (0.6%) | (1.6%) | (1.6%) |
| Overall HF Market | 0.5% | (4.6%) | (4.3%) |
| Managed Futures | (2.2%) | 18.5% | 17.4% |
Economic Indicators
| JUL-22 | JAN-22 | JUL-21 | |
|---|---|---|---|
| Equity Volatility | 21.3 | 24.8 | 18.2 |
| Implied Inflation | 2.6% | 2.5% | 2.4% |
| Gold Spot $/OZ | $1766 | $1797 | $1814 |
| Oil ($/BBL) | $110 | $91 | $76 |
| U.S. Dollar Index | 122.8 | 115.1 | 113.1 |
Our Take
The early read on Q2 U.S. GDP showed a 2nd consecutive quarterly decline and increased the probability that the U.S. economy has entered recession. There have been other negatives to be sure: While consumer spending grew in July, this marked its lowest contribution to growth since Q2 2020; and inventories shrank, with business sentiment as weak as it has been in a decade. If the data do not spell out an outright recession, they do underscore that inflation is taking a toll on the economy.
The labor market continues to be an outlier, indicating that a pending (or existing) recession may not be all that severe. Unemployment remains at record lows as the U.S. economy is still adding jobs, and wage growth (+6.7% annualized) is at the highest level since data collection began in 1997, having accelerated each of the last four quarters. More jobs and higher wages are not labor market characteristics typically seen in recessions. So, not everything is doom and gloom and these pockets of stability are a significant reason the Fed is charging ahead with rate hikes to address inflation.
How high will interest rates go? Futures markets pricing indicates that we can expect another 1 percentage point increase in the Fed funds rate, which is now at 2.25%-2.50%. While headline inflation continues to mark records relative to recent history, there are indications it will ebb. For example, much of the rise in the latest CPI inflation gauge comes from higher gas prices, which have since fallen 80 cents/gallon from their mid-June peak. Still, even if inflation begins to cool, it is still likely to remain above the Fed’s 2% target over the next few years. This is a meaningful portfolio consideration and warrants a continued emphasis on real assets, which are a cornerstone of our long-term philosophy.
Looking Ahead
Overall, the strong rebound in U.S. stocks in July (6.7% Dow Jones, 9.2% S&P 500, 12.4% Nasdaq) reinforced a critical premise of long-term investing: Attempts to time the market will likely prove fruitless as the majority of annual gains tend to occur in unpredictable short-term clusters.
This July, for example, bad news was good news, with investors betting the Fed interest rate hiking cycle would end sooner and lower than previously expected. That possibility is why you do not detour from your financial plan without a thoughtful assessment of objectives. We construct portfolios to achieve longer-term client goals, and the adjustments we make in the short term are in areas where we can identify ways to lower risk or increase return.
To that end, we are evaluating a range of emerging opportunities created by current trends, including credit dislocation and the on-shoring/near-shoring of industries deemed critical to national security.
