- Some Relief. US stocks staged a comeback in July, rebounding from a tough first half of the year. Moderating inflation expectations and better-than-feared corporate earnings helped delivered the best month of performance since 2020.
- High Prices. Official inflation data remains painfully high, both in the US and overseas, and remains the number one challenge facing the global economy. We believe a good deal of the present inflation is the result of pandemic dynamics (i.e. a perfect storm of massive government spending, supply chain problems, and low interest rates) creating excess demand in a supply-constrained environment.
- Peaking Inflation. We think disinflationary forces are gathering steam. A key commodities gauge has plummeted since reaching an all-time high in June. The global supply chain continues to recover, and we are actually starting to see inventory gluts in certain industries (e.g. retail). While rent and services make up a rising share of inflation, we believe the Fed outlook and action will depend heavily on the outlook of commodity prices.
- Q2 Corporate Earnings. Q2 earnings are far from perfect, but results are coming in a lot better than people feared. Companies that are especially exposed to underlying economic activity were mostly solid, and most point to economic activity and demand as fairly stable. In particular, the mega-cap tech companies put up respectable results, easing a significant concern among investors.
- A Moderating Economy. Changes in Fed policy impact the broader economy with a lag, but interest-rate sensitive sectors are already seeing some impact on demand. The housing market has seen a sharp increase in mortgage rates, which has weakened mortgage and refinancing originations. In contrast, the tight labor market continues to be a bright spot for the economy, with job openings still far outpacing available workers at present.
- Market Outlook. In contrast to a jittery market, corporate earnings remain firm, with few signs of an imminent economic slowdown. The market’s decline, so far, is largely due to lower stock prices, but not tied to lower earnings. Our expectation is for moderating growth from the economy’s present strength. Consumers are shifting their spending patterns, and we are fast-cycling the economic adjustments to bring down inflation. We expect the inflation story to improve organically as the extraordinary money growth of the past two years abates, while supply chains improve. We see the greatest continuing risk in energy and food costs remaining volatile here at home. Additionally, we are mindful of a looming recession in Europe, brought on by the energy price shock and the prospect for continued supply tightness.
