A Balancing Act

Where are we after a month with another Fed decision, updated economic and inflation reports, and a big earnings season? The highlights are:

• June’s Consumer Price Index inflation report was much higher than expected, at 9.1%
• The Federal Reserve raised rates 0.75%, the second consecutive increase of that degree and amounting to a historic level of tightening
• Preliminary Q2 GDP growth showed a second straight quarterly decline, on a seasonally-adjusted annualized basis, while unemployment has remained low
• Earnings were mixed, with certain companies continuing to show steady growth while others showed significant deterioration and weakness

This mix of news ultimately resulted in a late month rally as investors responded to the data, culminating in the S&P 500’s strongest month since November 2020, finishing the month up, 9.1%.

In fixed-income, the US 10-Year Treasury yield finished the month at 2.897%. The Fed’s implicit plan to pull back the pace at which it is raising rates is top of mind for fixed income investors as they await the next decision.

Our Perspective

The debate over the economy’s pockets of strengths and weaknesses continues to sway back and forth as investors consider the possibility of a looming recession. Our view is that the risk of recession in the US and other major economies has increased significantly.

As an active manager, we will continue monitoring macroeconomic developments and acting with caution by de-risking portfolios and positioning for an economic slowdown.  

Has Inflation Peaked? What the Bond Market Can Tell Us

While July’s Consumer Price Index (CPI) inflation report was certainly higher than expected, the bigger question is whether inflation is at its peak or going to stay hotter for longer.

The common inflation reports, like CPI and Personal Consumption Expenditures (PCE), unfortunately only highlight what has already happened. Instead, alternative measures such as using bond market gauges, known as market-based inflation measures, is an additional way for fixed income investors to evaluate economic indicators with a more forward-looking lens.

Our Perspective

By considering other inflation gauges, we can build a more complete picture of what’s to come. And for us, we believe that inflation is nearing a cyclical peak and will begin to cool off over the next few quarters. We see the tightening of financial conditions, a stronger US dollar, weaker demand in core goods as areas of relief, allowing the more cyclical inflation components to begin coming down from their peak.

We share more details in ‘Looking Over the Inflation Peak’.

There’s Always an Opportunity

Identifying trends, industries, and specific companies that will perform is the name of the game for our bottom-up investment analyst teams. The consumer goods sector is no exception.

The beauty industry’s use of digital marketing tactics, athleisure trends, and the consumers reliance on low-cost dollar stores during challenging economic times, are each long-term opportunities that our analysts uncovered for portfolios today.

Gain insight into those reasons and their process for identifying themes in the recent blog, ‘3 Stock Themes We Like’.  

Our View
Economic Cycle		The economy is moving later cycle with speed; a recession in the US is becoming increasingly likely; the Fed is on a warpath against inflation, as it has found itself badly behind the curve and is being forced by high and persistent inflation to tighten into an already weakening economy
Stock Market		US stock market volatility has dramatically picked back up; market weakness, coupled with relatively robust earnings growth, has improved valuations incrementally; however, equities remain expensive by longer-term historical standards; elevated valuations may be partly explained by robust corporate profitability, as EBIT margins have climbed to historical highs; rising input costs are posing a risk to the ability of corporations to maintain this elevated level of profitability; returns will be harder to come by and stock selection will be increasingly important
Bond Market		Interest rates have risen well off their lows reflecting shifting expectations on inflation, growth, and central bank policy; corporate and municipal bond credit spreads have widened, but not enough to make them materially more attractive at this time
Important Issues on the Radar		COVID-19: the worst of this economic crisis is behind us, and with multiple waves of the virus, including the Omicron variant, the attention is shifting to learning how to live with the virus; potentially impacting recovery, financial markets and currencies regionally
		Ukraine-Russia War: we believe an environment of elevated geopolitical risks over the coming months would entail a general risk-off environment; lending upward support to the dollar, gold, and commodity prices
		China’s Economy: China is an outlier regarding policy and has shifted to a gradual loosening stance while most of the developed world tightens aggressively; debt and property markets remain major issues; trade tensions continue to impact global trade and supply chains
		Inflation: a confluence of massive policy stimulus, tight labor markets, gummed-up supply chains, and rising energy costs are causing inflationary forces to broaden and become more entrenched than previously expected; conflict in Ukraine and lockdowns in China have added to price pressures

Sources: Wall Street Journal

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