Entering the second half of 2022, the stock and bond outlook is quite uncertain. Questions abound: Are we going into recession? Are we already in one? Will the Fed continue to raise rates to slow down inflation? Will the Fed pause raising rates if the economy shows signs of cooling and inflation begins to retreat on its own? Will corporate earnings slow down dramatically, or will they maintain themselves better than anticipated? There are lots of questions but no real answers yet.
The second quarter earnings season started on a sour note. Major banks were the first to report on July 14th, and earnings were dismal. Jamie Dimon, head of JP Morgan, said there would be "negative consequences from inflation," as JP Morgan profits dropped 28%. JP Morgan increased reserves due to increased requirements from regulators and suspended stock re-purchases until further notice.
Blackrock, the world's largest asset manager, reported in their quarterly call on July 13th that "investors reacted to the uncertainty associated with rising recession fears, surging inflation, interest rate hikes, and geopolitical tensions." These factors resulted in poor market performance during the year's first half. Investors should prepare for a new market landscape, no more Goldie-locks period for equities. Blackrock saw net inflows during the quarter, suggesting their platform's "diversified offering" as a positive; they agreed with RMR's philosophy of including more alternative options which will help clients when the "traditional hedge between stocks and bonds [weakens]." Our country is moving into a period of "stagnation," meaning the economy will continue to grow at a much slower pace.
There are always two sides to a coin, and it is no different with the investment outlook.
On July 7th, Barron painted a rosier picture moving forward. In his featured article, Andrew Bary wrote, "the economy looks resilient, and inflation is coming down. That could mean a solid second half of the year for stocks after a tough first six months that saw the S&P retreat 20%", the worse half year in fifty years. The June payroll report supported the upbeat scenario where payrolls rose 372,000 versus the estimated 250,000. "Should the Fed decide to pause, and the economy is not going into recession, we could be setting up for a strong stock rally," stated Jim Paulsen, Chief Investment Officer at Leuthold Group. Another positive outlook from Ben Levisohn of Barron's reports that TIPS (Treasury Inflation Protection Securities) are starting to price in lower inflation, with the 10-yr TIPS reflecting just 2.33% inflation, down from 3% in April. Similarly, commodity prices have fallen, and the dollar has risen.
"Second quarter earnings season begins July 14th, and expectations are for an increase of S&P earnings by 10.4% from 2021, with 5% earnings growth, but growth on both lines is expected to slow and profit margins to have narrowed," says Richard Bernstein, CEO of Richard Bernstein Advisors. He believes profits will be on the slow side, but he does not foresee a recession this year or next.
Only time will tell how the economy will fare in the year's second half and who will be right and wrong. Can the Fed create a "soft landing" for the U.S. economy?
Famed bond investor Rob Arnott, Founder, and Chairman of the Board of Research Affiliates, quoted former Federal Reserve Chairman Ben Bernanke, "economic expansions do not die from old age. The Central Bank murders them". That quote begets the question: Will the Fed, in their quest to slow down inflation, raise interest rates too quickly and too high, driving the economy into recession?
Many economists believe the Fed created a self-inflicted wound of high inflation with their use of massive stimulus spending from the beginning of Covid in March 2020. Last year, voices on Wall Street were calling for the Fed to begin tightening by raising rates and stopping the $60 billion a month bond purchases, fearing inflationary pressure. The Fed continued to claim that inflation was "transitory" and would slow down on its own. By November 2021, they dropped the word "transitory" at the Fed meeting in their prepared speech recognizing the Fed's mistake. Rob Arnott also believes inflation is much higher than 9% since rent inflation has not yet been factored in since it is a lagging indicator.
Echoing Arnott's remarks can be found in the release on July 13th of the Consumer Price Index Report. The report showed inflation running at 9.1%, reaching a 41-year high. The breath of inflation was staggering, with only airline fares showing a decline of 1.8%. The Daily Speculator went on to state that a very quick resolution is not to be found, the results of which can be traced back to a series of unfortunate political and monetary policy choices made over the past two years.
Slow Down in Home Sales
ETF.com wrote that the National Home Price Index grew 20.4% year-over-year as of April. March's gain of 20.6% was the fastest in history. The popular Case-Schiller Index now shows that growth has slowed down to 15% year over year. This slowing down makes sense as mortgage rates have doubled since the start of the year. Re-financing mortgages have virtually come to a halt. Most homeowners took advantage of super low rates to re-finance their mortgages and pull-out equity in their homes, helping to create the inflationary pressures we are experiencing today as too much money is chasing too few goods.
The RMR Investment Committee pays close attention to the investments we choose for our clients. We employ three separate investment committees, one for equities, fixed income, and alternative investments. All three make their case on recommendations to the full RMR Investment Committee for final discussion before approval is given to make changes every quarter. In volatile times like today, our nearly 40 years of investment experience thoughtfully guide our decisions.