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Edition 40: Perception is Reality

Perception is Reality

Signal Definer: Interference. Last month’s respite was replaced by a rout in both equity and bond markets, as rate increases fueled recession fears.

June Market Recap

The S&P 500 Index returned -8.39%

The Bloomberg U.S. Aggregate Bond Index returned -1.57%

Fed Funds Target Range: 1.50% – 1.75%

 

Economic Review

After a barely positive May, June saw the bear market return across indices. We ended up with the worst first half S&P 500 performance since 1970. A mid-month surprise 75 basis point rate hike at the June FOMC meeting was followed by Fed Chairman Powell’s testimony to Congress, which convinced markets that combating inflation is the priority for the Fed.

Are we headed for a recession? Are we already there? Or is the Fed’s plan to slow the economy and bring the labor markets into balance beginning to work?

  • The Atlanta Fed has created a model of GDP that attempts to forecast the key economic indicator, removing the lag of the official measure from the Bureau of Economic Analysis. The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2022 is -1.2 percent as of July 8th.
  • The official GDP number for the first quarter was a decline of 1.6%. If the GDPNow forecasts proves accurate for the second quarter, that would fit technical definition of a recession – two quarters of economic contraction
  • The June Manufacturing PMI® registered 53 percent, down 3.1 percentage points from the reading of 56.1 percent in May. This figure indicates expansion in the overall economy for the 25th month in a row after a contraction in April and May 2020. This is the lowest Manufacturing PMI® reading since June 2020, when it registered 52.4 percent
  • The U.S. Bureau of Economic Analysis (BEA) released the Consumer Spending estimate on June 30. Personal consumption expenditures (PCE) increased $32.7 billion, which equates to 0.2 percent – but inflation-adjusted spending dropped 0.4%
  • The U.S. Bureau of Labor Statistics reported total nonfarm payroll employment rose by 372,000 in June, well over consensus expectations. The unemployment rate remained at 3.6 percent.

And then the June CPI Number Landed

The CPI print blew past the upward expectations of 8.8% and came in at 9.1%. Yes, most of that was energy and we’ve already seen gas prices trend down over the last three weeks. But core CPI (excluding food and energy prices) was up too.

This not only means that a 75-basis point increase is likely at the July FOMC at the end of the month; it opens the door to a potential 100-basis point increase. The Fed has made a very concerted effort to communicate resolve in fighting inflation. At this point, higher increases may work on inflation. But the likelihood that consumers and corporations will see them as harbingers of recession and pull back on spending, making a recession more likely – a “doom spiral,” if you will – is coming into focus.

 

Market Review

The S&P 500 entered its 15th bear market (since 1928) declining over 20% from its Jan. 3, 2022, opening day closing high. The depth of the bear in June was on June 16th, when the index was down 23.55%. It closed the month down 21.08%. Trading slightly declined, as there was heavy selling at the beginning of the month but then a pull back. Cyptocurrency declined significantly.

The benchmark ten-year U.S. Treasury bond yield peaked at 3.47% on June 14, its highest reading since 2011, before falling to 3.02% at quarter end; it was up 17 bps for the month and 68 bps in the second quarter. The Bloomberg U.S. Aggregate Index had the worst first six months of the year since the inception of the index.  The index was down 1.57% in June and returned -10.35% year-to-date.  As represented by the Bloomberg Municipal Bond Index, Municipal bonds returned -1.63%.

US High Yield returned -6.81% in June and the year-to-date return was -14.03% as measured by the ICE BofA US High Yield Constrained Index (HUC0). Fear of a recession resulted in spread widening, with spreads increasing 166 bps to close at 589 bps.

In the alternative credit markets, The TMF Group’s Global Private Debt Insights Report from June 2022, found that 37.4% of respondents reported plans to increase their investment by more than 20%. TMF notes that this is the largest percentage represented in the data showing, a distinct trend for rising investment in the space.

The report went on to look at investor concerns about headwinds in the space, including inflation, labor shortages and interest rate increases: “Private credit investors, while being mindful of short-term headwinds, remain patient and focused on meeting long-term investment objectives, and ensuring broad diversification across portfolios and compensation for the risk taken.” 

Chart of the Month

Consumer Price Index

The nearly perfectly vertical line of inflation in 2022 captures the difficulty of the Fed’s task in lowering inflation while not pushing the economy into recession.

Source: Bureau of Labor Statistics

By The Numbers: A Directional Snapshot

  • Since 1956, eight out of 11 bear markets have coincided with a recession
  • Since the introduction of the CPI, the highest inflation rate observed was 20.49% in 1917
  • Plant-based meat has struggled for price parity with beef. With hamburger recently hitting $4.88 per pound, meatless Monday is looking more attractive

Source: Investopedia; Federal Reserve Bank of St. Louis

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