Wentz Weekly Insights
Worst First Half Since 1970, More of the Same For Q3
Trading last week continued to suggest investors are increasingly fearing a recession. The stock market continues to trade lower, down over 20% from the highs in January, while investors have favored defensive sectors such as consumer staples and utilities over the past several weeks, while riskier sectors such as technology have underperformed. The yield on the 10-year Treasury note has moved sharply lower in a short period of time, supporting bond prices (as interest rates fall, bond prices rise). Investors tend to favor less risky assets such as treasury bonds in a “risk-off” environment such as when there are recession concerns. The price of commodities, from things like oil, copper, and wheat, have continued to decline as well. When the economy is slowing, demand for these commodities is lower. For example, when construction slows, there is reduced demand for things like copper and lower prices follow.
Much of the concern stems from the (much needed) actions of policy makers at the Federal Reserve who are projecting a continued aggressive rise in interest rates in effort to combat high inflationary pressures. The current policy rate (the Federal Funds rate – what banks charge each other to lend excess reserves overnight) is 1.58% and policy makers expect that to be 3.4% by year end and 3.8% by the end of 2023. The worry that the Fed will raise rates too much too fast – and create an economic slowdown by destroying demand and creating a recession – has steadily increased over the past couple months.
This is being reflected in consumer’s feeling about current and future economic conditions. Last week, the Conference Board released results from its latest consumer confidence survey that showed sentiment fell to its lowest since the pandemic recovery began. More important, expectations are falling sharply with the index of expectations falling from 73.7 to 66.4 in June for its lowest reading in over a decade. These results mimic the University of Michigan’s consumer sentiment survey that showed the lowest reading on record dating back to 1970. The index on consumer sentiment was 50.0 in June, half of what it was before the pandemic began and falling from 70.6 where it started the year.
The concerns over an economic slowdown and market’s expectation of tighter financial conditions resulted in one of the worst first half of a year ever for basically every asset class beside commodities. The S&P 500 experienced a 20.6% decline in the first six months, while the NASDAQ saw a decline of 29.5% for its worst first half of the year on record. There were not many places to hide – bonds, which are less risky investments than equities, even saw the worst first half ever (going back to 1975). The Bloomberg U.S. Aggregate Bond Index, one of the more broad indexes of bonds, fell 10.7%.
It may feel that with how much we have heard about a recession that we are on path to talking ourselves into one. Don’t expect recession talks to go away any time soon either as new economic data rolls in. The Atlanta Fed’s forecasting model of GDP suggest the U.S. entered a technical recession in the second quarter after forecasting a 2.1% decline in GDP in the quarter, which follows a 1.6% decline in the first quarter, which would make it two consecutive quarters of contracting GDP. The forecasting model provides a good estimate on real time GDP based on the most recent economic data. Actual results on the first estimate of second quarter GDP from the Bureau of Economic Analysis will come on July 28.
Much of the pressure the market has seen over the first six months of 2022 will likely continue into the second half of 2022. Earnings season will begin next week with big banks reporting second quarter results, followed by a majority of S&P 500 companies the week after. The biggest question this earnings season is whether companies have been able to hold profit margins as costs rise at the fastest pace since the early 1980s. We maintain our view that defensive and income producing investments will hold up better in times like this and remain overweight these investments.
Week in Review:
Coming off one of the best weeks in years, stocks opened mixed on Monday with the energy sector the clear standout, outperforming with a move higher in oil. There was no news headlines to start the week with the path of least resistance continuing to be to the upside from oversold conditions. Value outperformed growth again as investors continue to favor defensive investments with the NASDAQ down 0.72% while the Dow was down just 0.20%.
Tuesday’s opening was met with encouraging news from China that there were no new Covid cases in Shanghai or Beijing, allowing additional restrictions to be lifted as well as cutting the quarantine time for foreign travelers into the country. Stocks got off to a positive start, but that was short lived as they headed deeply into the red and closed near the lows of the day. The index on Consumer Confidence fell for the second consecutive month with expectations at their lowest levels in over a decade over inflation concerns. It was another day of underperformance for growth versus value and all sectors with the exception of energy were down for the day with the S&P 500 falling 2.01%.
After the bell Tuesday Nike reported a mixed quarter with a lower 2023 forecast due to weakness out of China. It was another slow day from a headline perspective. Cleveland Fed president gave one of the more direct comments about a 75 basis point move at the next meeting, saying she supports such move if conditions remain the same and other remarks suggested it would be better to “overshoot” (tightening too much) versus not tightening enough and allowing inflation to become more entrenched. During the day global central bank policy makers gathered at a forum and made remarks on how inflation will be longer lasting and warned how tightening policy could end in a recession. Stocks were mixed for the day as value and defensive names again outperformed with the S&P 500 finishing the day down 0.07%.
Weak economic data from overseas, a drop in cryptocurrencies, falling commodity prices, and investors digesting remarks from the central bank forum led markets lower on Thursday out of the gate. Data from the morning showed consumer spending grew at a much slower rate than expected, and deeply negative after adjusting for inflation, while incomes continue to rise at an above trend pace, however still not keeping up with rising prices. In the monthly meeting between OPEC members, an agreement was made to increase production 648k bbl/day, but that is receiving a lot of skepticism given the lack of spare capacity. Stocks were not able to reverse losses and ended up closing down 0.88% for the day and ending the first half of the year down 20.6% for its worst performance since 1970.
Investors continued to sell risk assets in favor of more defensive investments with Treasury yields continuing to decline, cryptocurrencies in a free fall with Bitcoin below $20k, and growth underperforming. Manufacturing indices in the morning suggested the manufacturing sector is growing at its slowest pace since the early pandemic days. There were negative company headlines as well, with Micron providing current quarter forecast well below estimates due to weakening demand and Kohl’s saying sales will decline a few percentage points more than previously expected. However, markets saw a quick reversal, turning green and finishing up 1.06% on low volume.
Last week markets continued to trade on recession fears, with defensive sectors and value holding up better while risk assets like cryptocurrencies and growth stocks continued to sell-off. Treasury yields and commodity prices moved lower again last week on recession fears and weaker economic data. The 10-year Treasury yield, after reaching 3.50% just several days prior, fell from 3.20% on Monday to close the week at 2.89% while oil was relatively unchanged with commodities, particularly more economically sensitive ones like copper, lower overall. The major U.S. indices finished as follows: Dow -1.28%, Russell 2000 -2.15%, S&P 500 -2.21%, NASDAQ -4.13%.
Recent Economic Data
- New orders for durable goods rose 0.7% in May, well above expectations of a 0.1% increase, driven by gains in metals, machinery, and defense aircraft. Orders excluding the volatile transportation category (airplane orders can throw the headline number off sometimes due to the size of the orders), grew 0.7%, also above expectations. Compared to a year, ago durable goods orders are up 10.6%. The input to GDP, shipments of non-defense capital goods excluding aircraft, showed solid growth, rising 0.8% in the month.
- According to the S&P Case Shiller home price index, the national average for home prices rose 1.5% in April, right around expectations. Home prices are 20.4% higher compared to a year ago, down slightly from 20.6% in the previous month which happened to be one of the largest year-over-year increases ever. April’s increase ranked in the top quintile compared to historical data with about half the cities in the index seeing accelerating prices. Tamps (+35.8%), Miami (+33), and Phoenix (+31.3%) saw the fastest increases, while Minneapolis (+12.3%), Washington (+12.7%), and Chicago (+13.0%) saw the slowest growth, but still all up double digits.
- Consumers’ feeling about the economy continues to deteriorate with the index on consumer confidence, compiled by the Conference Board, dropping 4.5 points in June to 98.7 for a 16-month low. The present situations index fell slightly to 147.1 from 147.4 while the expectations index fell sharply to 66.4 from 73.7 for the lowest level in over a decade, consistent with the decline in the consumer sentiment survey as the lower expectations were driven by increasing concerns about inflation.
- The third/final estimate of first quarter GDP, using revised data from January-March, was adjusted downward slightly to a decline of 1.6% from a decline of 1.5% in the second estimate. The update was due to a small decrease in consumption offset by a small upward revision to inventory investment. More importantly, under the current environment, the GDP price index was revised upward, to an 8.2% annualized rate from 8.1% in the previous estimate.
- The number of claims filed for unemployment benefits to the states fell 2,000 for the week ended June 25 to a total of 231,000. The four-week average increased 7k to 231,750. The number of people continuing unemployment benefits was 1.328 million, down 3k from the week prior, bringing the 4-week average to 1.319 million, up slightly from the 52-year low the prior week.
- Personal income and outlays:
- Personal income rose 0.5% in May as expected and follows a 0.5% increase in April. However, with the PCE price index up 0.6% and the consumer price index up 1.0% in May, incomes are still not keeping up with inflation. The important wages and salaries component rose 0.5% in the month and is 11.3% higher than a year ago, above the 8.6% y/y inflation rate. Disposable income, which is after taxes, increased 0.5% in May and is up just 2.8% from a year ago (income was a little higher this time last year as some people were still collecting stimulus payments).
- Consumer spending slowed to a 0.2% increase in May, well below expectations. Real consumption, which adjusts for inflation, was down 1.2% in May and is down 0.2% from a year ago inflation-adjusted (+8.4% pre-adjustment) which means consumers are being forced to spend more to buy less. The shift to service spending accelerated as spending on goods, like vehicles and appliances, fell 0.7% in May, while spending on services rose 0.7% in May. The savings rate was 5.4%, up from 5.2% last month.
- The personal consumption expenditure price index, the Federal Reserve’s preferred measure of inflation, rose 0.6%, lower than the CPI’s read of 1.0%, while core prices rose 0.3%. Compared to a year ago the price index is 6.3% higher, matching April, and +4.7% for core prices, down slightly from April.
- The US Purchasing Managers Index for June signaled a slower improvement in the manufacturing sector, according to the PMI survey. The index was 52.7, dropping sharply from 57.0 in May for its largest drop since the early days of the pandemic. Factory output and new orders decreased slightly for the first decline in over two years. The report noted the reduction in new orders and rise in employment led to a greater success in clearing backlogs of work. Firms noted that inflationary pressures, weaker confidence in the outlook, and supply disruptions drove the decline.
- The index on manufacturing conditions based on a survey by the Institute of Supply Management was 53.0 for June, down 3.1 from May, suggesting activity grew at the slowest pace in two years. New orders declined in May, just like they did in the PMI survey. Many of the other categories continue to expand, such as production, backlogs, employment, and prices, but at a much slower pace than in recent months.
- Spending on construction fell 0.1% in May, versus the expectation of a 0.3% increase. The decline was due to a 0.6% drop in spending on nonresidential projects, partially offset by a 0.2% increase in residential. Compared to a year ago, spending is 9.7% higher, driven by an 18.7% increase in residential and 1.0% increase in nonresidential.
- Walgreens fell after the company confirmed that the sale of its Boots drugstore chain in the UK has been terminated. The company said it was due to no party being able to make an offer that reflected the value of the business and due to the “unexpected and dramatic change” in global financial markets.
- Spirit rejected an increased buyout offer from JetBlue, with shareholders set to vote on the Frontier deal on July 8. Spirit said the rejection is due to the fact the Board does not believe it would receive regulatory approval (it would become the 5th largest airline). It was just last Monday that JetBlue increased its offer (higher than Frontier’s) and increased its breakup fee.
- There is increasing speculation that Apple has been unable to develop a custom 5G modem of its own for its next generation iPhones as indicated by their latest supply-side surveys. The readthrough is positive for Qualcomm, who was concerned it would lose 80% of its business to Apple due to Apple developing its own 5G chips. Apple has been developing its own modems for about five years, helped by the $1 billion acquisition of Intel’s modem business in 2019.
- Kohl’s said it is ending its strategic review process and it will be ending its talks to be acquired by Franchise Group. It was two weeks ago that Franchise Group was reported to lower its takeover offer to $50 per share, down from $60 per share. At the same time, Kohl’s said it is seeing a softening in consumer spending and now expects sales to decline high single digits for Q2, versus its prior estimate of sales being down low-single digits.
- In his remarks at a forum on central bank policy hosted by the European Central Bank, Federal Reserve Chairman Jerome Powell reiterated the Fed’s “very strong” commitment on getting inflation down. He acknowledged the central bank’s risk of raising rates too far that it would push the economy into a recession, but said the bigger risk was to fail at bringing inflation down and having inflation become more entrenched into the system. Powell reiterated the Fed’s concern is the burden of inflation falling more on those that are less able to absorb the higher cost, more specifically those at the lower end of the income scale. Powell said he believes policy is working so far because of the success in delivering the Fed’s intention to the markets, noting the markets have been correctly interpreting the Fed’s guidance and is seeing tighter financial conditions already.
- OPEC+ concluded its monthly meeting with an agreement to add 648 barrels per day (bpd) of production for August. However, there is a lot of skepticism over reaching that target as the group has limited spare capacity and has struggled reaching production targets over the past year. If the group was able to meet targets for August it would put OPEC’s output back to levels it was at before it cut production during the early stages of the pandemic. UAE and Saudi Arabia are the two members that have spare capacity, reportedly around 3 million bpd combined, with Saudi Arabia’s output target of 11 million bpd by August a level it has only produced twice. Recall global oil production is near 100 million bpd.
- The Supreme Court ruled that the Environmental Protection Agency cannot take the approach that the Obama Administration adopted which included regulating greenhouse gas emissions from power plants, giving a setback to President Biden’s climate change plans and goals.
- The NATO military alliance is set to gain two new members, Finland and Sweden, after Turkey changed its mind to support the countries joining. Turkey originally opposed the two nations joining due to their support of the Kurdistan Workers’ Party which Turkey considers a terrorist group. The two countries committed to not providing support.
Did You Know…?
Busy Independence Day Weekend:
In the National Retail Federation’s annual Independence Day survey, 84% of respondents said they plan to celebrate the holiday this year and expect to spend $84.12 on food items, about $4 or 4.5% more than last year. Total spending on food is expected to be $7.7 billion, according to the survey, about 2.4% above last year.
The Transportation Security Administration (TSA) said TSA checkpoint volume was just a hair under 2.5 million on July 1, about 300,000 more than a year ago and about four times as much as two years ago. The seven day period prior to July 4, TSA throughput was 15.914 million, or 16% above the same period a year ago of 13.736 million.
Please be aware that starting after Memorial Day and running until Labor Day, Wentz Financial Group will begin its summer hours. Our hours on Monday will be 8:30 to 4:00 and Tuesday through Friday will be 9:00 to 4:00. As always, if you need to speak or meet outside of those hours, please reach out and we will be happy to set up an appointment.
The Week Ahead
Investors will have less to digest this holiday shortened week as the earnings and economic calendar will be lighter. The only notable reports on the earnings calendar include Levi Strauss and WD-40 on Thursday. We also expect monthly data from airlines and automakers like GM and Ford, which may include guidance updates. On the economic calendar, quarterly and monthly vehicle sales numbers will be released throughout the day Tuesday, along with factory orders for May. The ISM services index, job openings and labor turnover survey, along with the minutes from the Federal Reserve’s most recent June meetings are released Wednesday. On Thursday, the government releases data on weekly jobless claims and trade data while ADP releases its monthly figure on payroll growth for June. The main event is Friday when the DOL releases data for the labor market for June. Economists estimate 270,000 jobs were added in June after a 390,000 increase in May. It will be a little more quiet on the political front with Congress in recess until next week.