Wentz Weekly Insights
Inflation Continues to be Driven by Energy, But Becoming More Broad
Although it was another weekly decline for U.S. stocks, it was a strong finish to the week, helped by not as bad as feared results from banks, a just right retail sales report, a drop in inflation expectations, and markets giving a lower probability of a more aggressive 100 basis point interest rate hike in rates at next week’s FOMC meeting. However, recession fears remain in the market as the yield curve flattened more and is the most inverted since 2000 (investors see an inversion as a precursor to a recession).
Quarterly results from the big banks showed a large decline in investment banking fees, as a result of the volatile markets that brought very little M&A and IPO activity, a solid increase in equity and fixed income trading revenues, decent growth in consumer and business loans, but large builds in loan loss reserves. When there are signs or expectations that loans will not be paid back, banks will set aside cash for these potentially bad loans and did so by a large amount in the latest quarter, adding to investors’ recession fears.
The biggest headline last week was the inflation report that showed inflation rose at a much more than expected 1.3% pace in June, while being 9.1% higher than a year earlier. This is the highest inflation we have seen since 1981. The increase in prices was all across the board but seen the most in energy as gas rose another 11% in the month. This report reassured investors a 75 bps rate hike at the next meeting, but also caused markets to start pricing the chance of a full percentage point increase.
Although oil has receded in recent days, we believe there is upside to oil at current levels. This is important because oil is an input to so many things we consume – from heating up our homes to manufacturing goods. Oil futures moved lower by 7% last week and is down 25% from its highs, however at the same time Saudi Arabia hiked prices on the oil it is selling to Asia to a premium.
There is a physical market for crude and a futures market. The physical market is where traders buy oil from the producer and sell it to the refiner for consumption and is based on real time supply and demand. Then there is the futures market that allows traders bet on where oil will be at a certain point in the future and allows physical market participants to hedge their position. The futures price that we see in the media has declined recently because the worry there is a recession on the horizon due to an aggressive Fed which will lower demand and bring prices down in the future. Any economic slowdown and demand destruction will likely be mild, the current environment is still significantly undersupplied with low inventories, and global producers have very little space capacity, reasons we think oil will remain high until there is some sort of energy policy. Instead of focusing on punishing U.S. oil producers, the U.S. could look at ways to incentivize production.
Meanwhile, the futures market is beginning to imply the Fed will cut rates for the first time this cycle as early as February 2023. There is the wide expectation that because inflation is at multi-decade highs and more broad based and entrenched into the system that the Federal Reserve will have to hike rates enough to drive the economy into a recession. Markets have pulled that expectation up to the first half of 2022. While thinking of the word recession might bring flashbacks of the Financial Crisis in the late 2000s, a recession is not always as deep, severe, or long-lasting as that – it is important to keep in mind a recession is just a broad-based decline in economic activity over a period of time.
Week in Review:
Stocks got off to a slow start on Monday, if there was any blame it is on new Covid worries in Asia. There were new cases of the new highly infectious Covid subvariant seen in Shanghai, bringing back lockdown concerns, in addition to Macau, a massive gambling center near Hong Kong, announcing a lockdown including closing casinos for a week. Fed speak for the day included Kansas City’s Esther George supporting rate hikes but voicing her concern on doing so too quickly, while Boston’s Bostic reiterated his support for a 75 bps rate hike at the next meeting. Stocks moved lower through the day with a large underperformance from growth versus value with defensive sectors taking the lead again. The S&P 500 lost 1.15% while the NASDAQ fell 2.26%.
Tuesday was another relatively uneventful day, but the last hour of trading saw a sharp selloff, sending stocks lower for the day with all 11 sectors finishing lower. There were additional Covid concerns out of China, which sent oil down 8% and below $100/barrel again. The yield curve remained inverted with the spread between the 2-year and 10-year yield the most negative since 2007 while the S&P 500 finished 0.92% lower.
Wednesday’s headline was the consumer price index report that showed inflation accelerated in June, rising a more than expected 1.3%, the highest since 2005, and was 9.1% higher over the last 12 months, the highest since 1981, leading investors to start betting on a larger full percentage point rate hike at the next Fed meeting. Delta reported mixed results in the morning but says demand remains very strong which has created “operational stress.” Energy was in focus as well as the IEA and OPEC said it expects demand to outstrip supply by at least 1 million barrels/day through 2023. Markets closed well off the morning lows with the S&P 500 down just 0.45% while the yield curve inverted more.
Stocks got off to a slow start again Thursday after disappointing earnings results from JPMorgan, which built more loan loss reserves and suspended share buybacks while warning about the uncertain future, along with Fed comments that “everything is in play” as markets put a higher probability of a full percentage point rate hike for the next meeting. However, similar to yesterday stocks were able to reverse and move higher to close near the highs of the day after more Fed comments that a 75 bps rate hike is most likely. The S&P 500 fell just 0.40% despite breadth overwhelming to the downside.
On Friday, markets built on Thursday’s second half of the day rally by finishing higher for the first time in five days. Stocks were boosted by better bank earnings reports, a just right retail sales report that showed sales grew 1.0% in June, and a drop in inflation expectations from the latest consumer sentiment survey. In global news, China’s GDP came in lower than expected, as growth was negatively impacted by Covid lockdowns. It was a good day for stocks with all sectors participating to the upside with the S&P 500 gaining 1.92%.
Despite a strong finish to the week, stocks still settled lower for the week. The yield curve inverted more, with the spread between the 2-year and 10-year Treasury yield at its widest since 2000 as the 2-year yield moved up several basis points to 3.13% while the 10-year moved down to 2.93%. It was another volatile week in the energy and commodity markets, with oil settling 7% lower for the week. The major U.S. indices finished as follows: Dow -0.16%, S&P 500 -0.93%, Russell 2000 -1.41%, and NASDAQ -1.57%.
Recent Economic Data
- The New York Fed’s Survey of Consumer Expectations found expectations for the year-ahead inflation increased to a series high of 6.8%, up from 6.6%, while the three-year inflation expectation fell to 3.6% from 3.9%. Consumer’s expectation for home price growth over the next year fell sharply to 4.4% from 5.8% in the prior month. Meanwhile, the expected probability of losing a job moved higher.
- Inflation was hotter than expected for June according to the consumer price index (CPI) which showed prices rose 1.3% in the month, above expectations of 1.1% and the largest monthly increase since 2005. The CPI rose 9.1% from a year earlier, versus expectations of 8.8% and accelerating from 8.6% in May, for the largest 12 month increase since 1981. The increase was broad based with the largest monthly increase in gas (+11.2%), shelter (+1.0%), and food (+1.0%) which has seen its sixth consecutive monthly increase of at least 1%. Core prices, which exclude the two most volatile categories of energy and food, rose 0.7% in June while the year-over-year number increased 5.9%. The largest category, housing rents, accelerated in June and rose 0.7% with rental prices seeing the largest increase since 1986. Vehicles continue to rise in price with new vehicles and used vehicles up 0.7% and 1.6% in the month and 11.4% and 7.1% over the past 12 months, respectively. Transportation services saw a 2.1% increase, but airlines fares were one of the only major categories seeing a decline in the month, down 1.8%, but still 34% higher than a year ago.
- The rise in producer’s input prices accelerated in June, rising 1.1% in the month, more than the 0.8% that was expected and higher than May’s increase. The increase was driven by a 10% increase in energy costs. Compared to a year ago prices were 11.3% higher, just short of the 11.5% rate that was seen a couple months earlier. Excluding the volatile food and energy categories, producer prices rose 0.4%, meeting expectations with the 12-month change at +8.2%, down from 9.7% in May.
- For the week ended July 9, there were 244,000 claims for unemployment insurance, rising slightly from 235,000 the week prior. The four-week average was 235,750. The number continuing unemployment insurance was 1.331 million, down 41k from the prior week, with the four-week average moving slightly higher to 1.339 million.
- Retail sales rose by 1.0% in June, slightly more than the 0.9% increase expected and follows a small decline from May. Since June last year, sales have grown a solid 8.4%. However, it isn’t all that good as all of the increase in sales is due to higher prices with consumers being forced to pay more to buy the same amount of goods. Adjusted for inflation retail sales were down 0.3% in June and down 0.7% from a year earlier. Details show four of the 13 major categories saw an increase in sales, driven mostly by a 3.6% rise in gasoline sales, 2.2% increase in online sales, and a 1.4% increase from furniture stores. Vehicle sales rose 0.9%. Largest decline was seen in building materials. Excluding the more volatile vehicle and gas categories, core retail sales rose 0.7% versus the expected 0.2% decline.
- The Empire State Manufacturing Survey index rose to 11.1, indicating expanding conditions and a large bump in July compared to June. New orders showed a small increase, shipments saw strong growth as manufacturers work through backlogs, while unfilled orders continue to shrink. Employment remained strong. Around 34% of respondents said conditions improved while 23% said conditions worsened in the beginning of July. The report noted firms have become pessimistic and now expect activity to decline over the next 6 months, only the fourth time the survey has ever returned with those results.
- Consumer sentiment, from the University of Michigan consumer survey, had an index level of 51.1 for the mid-month July reading, up slightly from the all-time low of 50.0 last month. Current conditions index was 57.1, improving from 53.8 last reading, while the expectations index was 47.3, down slightly from 47.5 for the lowest since 1980. Inflation expectations improved slightly with short-term inflation expected.
- Boeing’s airplane deliveries topped 50 in June for the first time since March 2019, the same month its 737 MAX crashed that resulted in a grounding of the plane for almost 2 years. It delivered 51 airplanes in June and 216 over the first half of the year, a 38% increase from the same period last year.
- The interactive/connective fitness maker Peloton said it will begin outsourcing to Taiwan with its manufacturing partner Rexon Industrial, a move to end its in-house manufacturing. The move is part of the company’s cost-cutting efforts and simplifying its supply chain as it seeks a path to profitability.
- American Airlines made gains last week after saying it expects profits to be higher than expected due to stronger demand with revenues 12% higher than 2019 levels, which is the last peak in airline travel. The next day, Delta reported its quarterly results that were mixed – revenues were strong as demand remains very strong with higher operational and fuel costs. The company provided upbeat guidance for the current quarter, but the CEO admitted airlines “pushed too hard” coming out of the pandemic in attempt to capture as much demand as possible which created “operational stress” that airlines are dealing with now.
- Netflix announced it is choosing Microsoft to be its advertising and technology partner to help it bring its ad-supported service to the market. Netflix said “Microsoft offered the flexibility to innovate over time on both the technology and sales side, as well as strong privacy protections for our members.”
- After Elon Musk said he was terminating his deal to buy Twitter over concerns with its fake/spam accounts, Twitter said it will file a lawsuit on Musk to “hold Elon Musk accountable to his contractual obligations” claiming “bad faith” efforts.
- Amazon said it is reducing the number of items it sells under its own brands by well more than half over disappointing sales for many of its items. The company has even been discussing the possibility of exiting the private-label business to alleviate regulatory pressures after several members of Congress called out the company for giving advantages to its own brands at the expense of third party seller products.
- Intel is informing its customers it will start raising prices on its chips due to rising cost pressures that could range from single-digits to up to 20%.
- Bank that reported Q2 results last week reported mixed results. The trend was a sharp decline in investment banking revenues, due to less activity in activity like mergers and acquisitions and bringing offerings to the market, a rise in fixed income trading revenues, decent growth in consumer and business loans, and large builds in loan loss reserves. JPMorgan said its investment banking revenue fell 32%, fixed income trading revenue rose 15%, while its consumer banking revenue grew 9%. It also built another $428 million in reserves for potentially bad loans while Citigroup built $400 million. Its net interest income improved which led the company to increase its guidance (this is the amount banks make on loans, after paying interest on deposits). JPMorgan CEO made remarks that the consumer and businesses remain strong, but the future is less certain due to geopolitical tensions, high inflation, waning consumer confidence, the uncertainty on how high rates will go and the quantitative tightening by the Fed.
- Data from real estate brokerage firms are showing Americans are canceling deals to buy homes at the highest rate since the pandemic began. About 15% of home that went under contract in June were canceled in the month due to higher mortgage rates and higher home prices, causing many homebuyers to reconsider their purchases. The 30-year mortgage rate averaged 5.51% last week, up after two consecutive weekly declines, according to Freddie Mac’s weekly mortgage survey. The 30-year rate hit a high of 5.81% three weeks ago, up from 3.11% where it started the year.
- The euro hit parity with the U.S. dollar for the first time in 20 years after a sharp move higher in the dollar over the past year and a weakening of the euro. While the dollar has strengthened due to a strong economy and tighter monetary policy, the euro has weakened over political instability, the energy crisis, and the war in Ukraine. While a weaker euro is a concern for policy makers in Europe, the stronger dollar has a negative impact on U.S. companies that exports goods and services overseas. Many global U.S. companies reported impacts from foreign exchange in Q1 that affected the bottom line, and we expect that to intensify this earnings season as the dollar has only strengthened more.
- Due to capacity and labor constraints, Heathrow Airport (London) said it will be implementing a departing passenger cap of 100k per day until mid-September, while asking airlines to refrain from selling summer tickets.
- Joe Manchin (Senate Democrat from WV) tells the party leaders he will not support a new spending package on climate measures or tax increases. Democrats are trying to revive a spending/reconciliation bill that targets these two areas, among others, and need Manchin’s vote to hit 50 votes and allow the bill to pass in the Senate.
Did You Know…?
Dividends on U.S. stocks rose again in the second quarter, hitting another record, but rose at a slower pace than in the first quarter. Dividends increased by $19.3 billion in the second quarter, well below the $27.7 billion increase seen in Q1, but improving from Q2 2021 where we saw a $15.4 billion increase, according to data from S&P Dow Jones. There were 398 of the 503 companies in the S&P 500 that distributed a cash dividend and the total paid out in dividends by those S&P 500 companies was $140.6 billion in the quarter, up 2.2% from Q1 and up 13.9% from Q2 2021. The report notes dividend increases are expected to continue to increase in Q3 despite the market retreat.
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
This week’s calendar will be dominated by earnings reports as earnings season heats up with about 75 S&P 500 companies set to report second quarter results. Notable releases will include Bank of America, Goldman Sachs, and IBM on Monday, Netflix, Johnson & Johnson, and Hasbro on Tuesday, Tesla, United Airlines, CSX, Las Vegas Sands, and Biogen on Wednesday, AT&T, Snap, Philip Morris, and Dow on Thursday, and American Express, Twitter, and Verizon on Friday. Elsewhere, investors will take note of the Farnborough International Airshow where historically new deals are announced and has been where airlines announced new purchases. The economic calendar is less busy, but still includes some notable reports from the housing sector. On Monday the housing market index is released, followed by housing starts and permits on Tuesday. Then we will see figures on existing home sales for June where the consensus sees a 5.4 million annualized sales pace in the month, about steady with May’s pace. The weekly update on jobless claims, along with the Philly Fed manufacturing survey, will be released Thursday. There will be central bank meetings from the Bank of Japan (expected to keep policy unchanged) and the European Central Bank, who is expected to raise rates, although keeping them in negative territory. Federal Reserve members will be in a quiet period ahead of next week’s FOMC meeting.