Commentary provided by Mark Szycher, Vice President, Investment Specialist, AIG Retirement Services
Market Performance Snapshot* (Week ending June 24, 2022 and year-to-date)
- Dow Jones Industrial Average®: +5.4% | -13.3%
- S&P 500® Index: +6.4% | -17.9%
- NASDAQ Composite® Index: +7.5% | -25.8%
- Russell 2000® Index: +6.0% | -21.4%
- 10-year U.S. Treasury note yield: 3.14%
- Down 10 basis points from 3.24% on June 17, 2022
- Up 163 basis points from 1.51% on December 31, 2021
- Best-performing S&P 500 sector this week: Consumer Discretionary, +8.3%
- Weakest-performing S&P 500 sector this week: Energy, -1.6%
*Past performance is no guarantee of future results.
Stocks power through recession fears to notch weekly gains
Equities rallied from last week’s steep fall and Treasury yields declined as markets continued to navigate the twin concerns of inflation and recession. All major indices rose more than 5%, with the tech-heavy NASDAQ Composite surging 7.5%, helped by lower Treasury yields and investors seeking opportunities in some companies that were well off their most recent highs. Every S&P 500 sector except energy was positive for the week.
- While the rise in equities indicated investor confidence, movements in Treasuries signaled concerns about economic growth. After rising to start the week, Treasury yields fell sharply as recession concerns pushed some investors back toward the safety of Treasuries (Treasury yields move down as prices move up).
- The 10-year yield—typically very sensitive to economic growth assumptions—fell back to 3.02% on Thursday morning, more than 45 basis points below the recent closing peak on June 14. The 2-year yield—typically very sensitive to Fed policy expectations—dipped to 2.92% on Thursday morning, 50 basis points below its June 14 high, even as Fed officials continued to signal their commitment to raising rates to fight inflation. Both yields climbed on Thursday afternoon and Friday but declined for the week.
- New weekly unemployment claims were 229,000, slightly below the prior’s week upwardly revised level. The figure has been above 200,000 for seven of the last eight weeks after spending the previous ten weeks below 200,000. It’s unclear whether this signals labor market softening. The latest 4-week moving average of continuing claims was 1.31 million, the lowest since January 1970. Several high-profile firms including Tesla, JPMorgan, and Netflix have recently instituted layoffs, providing further evidence of a broader economic slowdown.
- The University of Michigan’s final consumer sentiment index for June showed consumers’ inflation expectations for the next five years rising to just 3.1% from last month’s 3.0%, though uncertainty around inflation expectations is very high. Jay Powell specifically noted this month’s preliminary University of Michigan report—which saw five-year inflation expectations jumping to 3.3%—as a reason why the Fed boosted the federal funds rate 75 basis points instead of the expected 50 basis points. The overall consumer sentiment index fell to a record low of 50, down from 58.4 in May and 85.5 one year ago.
- President Biden called on Congress to suspend federal gasoline (18.4 cents/gallon) and diesel (24.4 cents/gallon) taxes through September to help consumers. Lawmakers in both parties were lukewarm to the proposal. Biden also asked states to pause their gas and diesel taxes or offer other consumer assistance.
- Despite a rally on Friday, oil futures prices continued their recent fall, coinciding with increased recession fears. U.S. benchmark West Texas Intermediate futures declined about 2.2% for the week and are down about 12% from their most recent closing high on June 8. Gasoline futures are down about 11% over that time.
- According to the American Automobile Association (AAA), average pump prices have dipped to about $4.93/gallon after surpassing $5.00/gallon earlier this month, although remaining about 35 cents/gallon higher than in late May.
- Recent reductions in natural gas deliveries from Russia prompted Germany to move to the second stage of its three-stage gas shortage management plan. While stopping short of rationing gas (which comes in the third stage), the move incentivizes businesses to use less gas and allows coal-burning power plants to be restarted. German law requires gas reserves to be at 90% heading into winter, well above the current 58%, according to the country’s economy minister. European natural gas futures prices have risen nearly 60% in the past two weeks.
More signs point to slowing economy
Several major banks and economic forecasters have raised their probabilities of a U.S. recession this year or next, though most view a potential recession as likely to be relatively mild. Models that track incoming economic data are also flashing warning signs.
- The New York Fed’s economic growth model now predicts a 0.6% decline in U.S. GDP this year and a 0.5% decline next year—worse than forecasts made in March. The Atlanta Fed’s GDPNow tracker forecasts GDP growth in the current quarter of 0%, down from the 0.9% growth estimate earlier this month and 2% growth forecast in May.
- S&P Global reported U.S. services activity in June grew at the slowest pace in five months and manufacturing output contracted for the first time in two years. According to the report, “Business confidence slumped to one of the greatest extents seen since comparable data were available in 2012, down to the lowest since September 2020. Manufacturers and service providers were far less upbeat regarding the outlook for output over the coming year than in May, principally amid inflationary concerns and the further impacts on customer spending as well as tightening financial conditions.”
- In another sign of a slowing housing market, existing home sales fell 3.4% in May from April and 8.6% from May 2021, according to the National Association of Realtors (NAR). It was the fourth consecutive monthly decline and the lowest annualized rate of sales since June 2020.
- May’s average sales price of $407,600 was 14.8% higher than May 2021 and the first time on record above $400,000. Rising prices and mortgage rates are contributing to lower sales. NAR’s chief economist said, “Further sales declines should be expected in the upcoming months given housing affordability challenges from the sharp rise in mortgage rates this year.”
- The Commerce Department said new home sales rose 10.7% in May after falling 12% in April, but remained 5.9% below the May 2021 level.
- The Mortgage Bankers Association (MBA) reported 30-year fixed mortgage rates jumping 33 basis points to 5.98%in the week ending June 17, as the Fed’s latest interest rate moves and higher Treasury yields filter into consumer lending. Rates are now the highest since November 2008 and “almost double what they were a year ago, leading to a 77% drop in refinance volume over the past 12 months,” according to the MBA. While home equity levels remain historically high, consumers may be less inclined to tap the equity at higher interest rates.
The big question: Can the Fed tackle inflation without precipitating a recession?
Questioned by U.S. senators Wednesday about the possibility of rate hikes tipping the economy into recession, Fed chair Jay Powell said, “It’s not our intended outcome at all, but it’s certainly a possibility, and frankly the events of the last few months around the world have made it more difficult for us to achieve what we want, which is 2% inflation and still a strong labor market.” He added, “The question of whether we’re able to accomplish [our goal] is going to depend to some extent on factors that we don’t control.”
- Responding to a question from Sen. Elizabeth Warren (D-MA), Chair Powell stated that rate hikes would moderate demand by slowing demand for interest-rate-sensitive durable goods such as autos, prompting households to restrain spending as wealth declines from lower stock prices and home values, and a stronger U.S. dollar reduces exports.
- Responding to a question from Sen. Richard Shelby (R-AL), Powell stated that “price stability is the bedrock of the economy.” Powell also stated the Fed’s mandated goal of maximum employment cannot be achieved without fulfilling its other mandated goal of price stability.
- Other Fed officials offered mixed forecasts on the economy and the Fed’s upcoming moves. St. Louis Fed president James Bullard said, “U.S. labor markets remain robust, and output is expected to continue to expand through 2022.”
- Richmond Fed president Tom Barkin told a risk management conference, “Historically, eight of the last 11 Fed tightening cycles have been followed by some sort of a recession,” while also noting, “A slowdown from our current situation must be kept in perspective … Returning to normal doesn’t have to require a calamitous decline in activity.”
- Philadelphia Fed president Patrick Harker said, “We could have a couple of negative quarters” of GDP growth, but he wouldn’t necessarily consider that a recession. (There is no hard and fast rule on what constitutes a recession, though many consider two consecutive negative quarters to be a recession.) Harker also said he is “between 50 and 75” basis points for a July rate hike, depending on forthcoming data.
- Fed governor Michelle Bowman said, “Based on current inflation readings, I expect that an additional rate increase of 75 basis points will be appropriate at our next meeting as well as increases of at least 50 basis points in the next few subsequent meetings, as long as the incoming data support them.” Fed governor Christopher Waller said, “If the data comes in as I expect, I will support a similar-sized move [to June’s 75 basis point hike] at our July meeting.”
Final thoughts for investors
Market concerns about recession and inflation continue to whipsaw investors as economic data points in different directions. While Fed officials and other policymakers signal their determination to whip inflation, factors outside their control—from supply chain challenges to geopolitical developments—will continue to cloud the picture. Amid continued volatility, stay focused on long-term goals and speak with a financial professional.
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