The S&P 500 Total Return Index is currently down roughly 12% for the year, well above its low of down 23% on June 16, but still a long ways from a full recovery. For bonds, the U.S. 10-Year Treasury Yield remains volatile, swinging between 2.5%-3.5% since early April. Its current 3.1% level is roughly double the 1.5% from December 31, 2021. Will stocks and bonds go on to set new lows or record highs before year-end? While neither we at GGS, nor anyone else, truly know the answer to this question, we strive to incorporate the key inputs into our dynamic modeling process. Most likely, future near-term returns will depend on how the following key events transpire versus expectations:
- Inflation: There are several different measures of inflation, but the Consumer Price Index (CPI) from the Bureau of Labor Statistics has caused the biggest recent market reactions.1 The CPI peaked at +9.1% year-over-year in June, fell to +8.5% in July, and very likely needs to continue this downward trajectory for both stocks and bonds to move higher. The key inputs into the CPI are the costs of shelter (32%), food (13%), energy (9%), new/used vehicles (8%) and healthcare (7%).2 Some of these metrics may have already peaked while others are still rising, even within the same broad category. For example in shelter, home prices have flattened recently as higher mortgage rates make homes less affordable,3 while rent prices continue to march higher as older leases expire and reset at the new higher levels.4 The CPI for August will be released on September 13 and will again be a key focus point for the market.
- Global Growth: Between continuing COVID lockdowns, supply chain issues, rising input costs, consumer wallets being pinched, war, and severe droughts, global corporations and governments have a lot to deal with at the moment. The good news is that, overall, recent corporate earnings announcements and forward-looking guidance have come in better than feared. Companies continue to make the real-time adjustments needed to keep their operations going and limit profit margin impact as growth has slowed. The next market-moving corporate updates will come from CEO and CFO presentations at major industry conferences set to take place August 30-September 14.5 Various economic releases happen almost daily around the world, but the market will be focused on:
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- August 31, China’s Purchasing Manager’s Index: Whether China continues to emerge from its self-imposed COVID-lockdowns is a key variable for global growth and supply chains.
- September 2, US Jobs Report: The market wants to see a “Goldilocks” number in the 100-200k range for job adds. A higher number may cause more inflation worries while a lower number raises recession risks.
- September 5, OPEC Decision: While not an economic release, the price of oil is a key driver in the global growth vs. inflation debate. A change in production by OPEC, or if a separate deal is reached to allow Iranian crude back on the market,6 would be impactful to markets.
- Central Banks: All eyes will be on Jackson Hole, Wyoming, tomorrow as Fed Chair Powell delivers his address to set expectations for what will happen at upcoming Federal Reserve meetings. Keep in mind that the US Jobs Report on September 2 and CPI on September 13 are likely more important for future Fed policy than Powell’s speech, but we would expect analysts to debate his every word anyways. Investor expectations are for either a 0.50% or 0.75% hike at the September 21 Fed Meeting, and for the Fed Funds Rate to be just north of 3.5% by December 31 (vs. its current 2.3%).7 The European Central Bank (ECB) and the Bank of England (BoE) are also expected to continue hiking interest rates to combat high inflation at the upcoming September 9 ECB and September 15 BoE Meetings.8
- Geopolitics: Unfortunately, there do not appear to be any signs of a near-term resolution to the Russia/Ukraine war. If a peace agreement is reached, it would be a major positive surprise for markets, particularly European-based companies which are currently struggling under the weight of astronomically high gas prices. On the other hand, we do not believe investors are currently pricing in much risk of significant negative developments in the China/Taiwan dispute. Therefore, if a real war was to occur there with Taiwan under prolonged blockade and/or missile attack, this would likely cause a severe negative reaction from markets given how integral Taiwan’s semiconductor production is to the global economy.9 Closer to home, we do not expect the upcoming US midterm elections to have a major impact on the market. The Democrats just passed their major legislation, while a Republican majority in the House and/or Senate implies at least two years of gridlock in Washington. Historically, markets have tended to rally following midterm elections, presumably because some uncertainty is removed from the market,10 but given the likely lack of major near-term economic changes from either outcome, we are not expecting a large market reaction.
Bottom Line:
At GGS, we do not attempt to forecast future macroeconomic events or time the overall market. That said, we do pay close attention to the issues and risks above and how they could impact both the individual companies we are buying and the overall risk profile of client portfolios. For example, while a China/Taiwan war would be negative for all companies, we make sure to measure and limit overall client exposure to companies most directly impacted. We do not strive to completely eliminate this risk, as in investing you are paid for assuming risk, but instead we factor this negative tail risk into our analysis and demand that these companies meet a higher bar than those not as directly exposed. We continue to recommend that clients stay the course at the target risk level best suited for your individual circumstances and remain invested in high quality companies.
Footnotes:
1 In particular, the CPI for May (released on June 10) is widely blamed for sending the market to its June 16 lows. Investors expected the May CPI to continue the downward trend from April but it instead showed an increase.
2 https://www.bls.gov/news.release/pdf/cpi.pdf
3 https://www.redfin.com/us-housing-market
4 https://abcnews.go.com/Business/skyrocketing-rents-pain-tenants-inflation-rises/story?id=87239462
5 Jefferies 2022 Semiconductor, IT Hardware and Communications Infrastructure Summit 8/30-8/31; Deutsche Bank Technology Conference 8/31-9/1; Barclays Energy-Power Conference 9/6-9/8; Bank of America 2022 Media, Communications & Entertainment Conference 9/7-9/8; Barclays Consumer Staples Conference 9/7-9/8; Citigroup Global Technology Conference 9/7-9/9; Goldman Sachs Global Retailing Conference 9/7; Baird Global Healthcare Conference 9/13-9/14; Barclays Global Financial Services Conference 9/13-9/14; RBC Industrials Conference 9/13-9/14, etc.
6 https://www.bloomberg.com/news/articles/2022-08-24/iran-has-its-eye-on-russia-sized-hole-in-the-european-oil-market
7 https://www.atlantafed.org/cenfis/market-probability-tracker
8 https://www.dailyfx.com/forex/fundamental/central_bank_watch/2022/08/16/central-bank-watch-boe-ecb-interest-rate-expectations-update-august-16.html
9 Taiwan produces more than 90% of the world’s most advanced semiconductors, according to Reuters: https://www.reuters.com/investigates/special-report/taiwan-china-chips/
10 https://www.usbank.com/investing/financial-perspectives/market-news/stock-market-performance-after-midterm-elections.html