The confluence of challenges facing the economy and affecting the market is staggering. In short, we’re living in a period with a historic rate of inflation coupled with very low unemployment, a housing market that has been on a tear, a virus that won’t go away, and a war that likely won’t end soon. This article touches on our thoughts on the present, and our guidance for managing expectations through the next three to six months of this tumultuous time.
To set the stage, consider the moderating of GDP growth. The forecast from the Bureau of Economic Analysis for the first quarter of 2022 indicated a contraction of 1.4% in GDP over the 6.9% figure from the prior quarter. Surely, inflation is having a significant impact on spending, and the situation globally is challenged as well, with net exports down 3.20% quarter-over-quarter, indicating continued weakness in foreign trade. Other recent metrics that indicate the economy is slowing include the national savings rate having dipped to +6.6% from +7.7%, and real disposable income falling 2% as a result of inflation-eroded wages.
With inflation at such high levels, impacts to spending were expected. It was also expected that the Fed would continue to move forward with interest rate increases to rein in inflation. The half point rate increase recently was both expected and celebrated. Given the accompanying commentary from the Fed, the increases are expected to continue at a relatively steady clip through the summer months. The challenge is fairly clear with recent inflation measured at 8.01%, the Fed will have to raise rates significantly in the coming months. The hope is that inflation will contract and that the two rates will come into an approximate balance. Some estimates indicate that it may take as many as four one-half point increases to reach a short-term Fed rate of 2.5%. And, it’s not clear whether that will be adequate to bring inflation back to the same level by the end of the year.
Importantly, both the extent of the rate hikes and their frequency are expected to provide some relief to inflation, which is having a direct and significant impact to prices. Consumers are particularly impacted at the gas pump and the grocery store. With heightened fuel prices, transportation costs involved with getting goods to market are difficult to avoid. While the Ukraine conflict has challenged oil and natural gas prices across the globe, the overall effects to the U.S. economy from the conflict are minimal. This is not the case for most of Europe.
Fundamentals for many U.S. companies have generally been solid, but pockets of weakening guidance and missed earnings occur, as is always the case. Interestingly, the burgeoning trend for evaluating the worth of a firm is no longer its historical revenue and earnings, which are both rearview facing, rather, future guidance is the new rage. The recent cases of Apple and Microsoft are noteworthy as their quarterly earnings should have been deemed spectacular but their share prices were both pummeled as though they had missed their estimates, as a function of weakening future guidance.
Not only has the street become increasingly more judgmental about the health of a firm, but the landscape of the businesses themselves have shifted dramatically. Many firms continue to foster remote workers, with others welcoming or requiring a return to company real estate-based offices. The transition out of the pandemic has been lengthy but it’s clear that workers have returned to jobs, and companies have benefitted from the increased spending by the public at large. To some extent, a return to pre-pandemic spending preferences is beginning to emerge through instances of reports of a declining Netflix subscriber base, and the recent quarterly earnings miss by Amazon. Both indicate that many consumers have aborted the virtual marketplaces to an extent, perhaps in favor of other substitutes. Importantly, for much of the country, consumer spending may be at the tipping point with handling higher prices and rising interest rates.
The robust housing market is expected to cool following the bulk of the rate increases. Higher mortgage rates and accompanying expenses should prompt would-be buyers to reevaluate their outlays when locking in at higher rates for the long haul.
It’s clear the markets have become more volatile in recent weeks, appearing to buck the pending reality of the brewing higher short-term interest rates, weaker guidance, the Russia-Ukraine crisis, and the remnants of the global pandemic. If you are looking for evidence of this, think back to Friday, April 22nd when we saw a thousand-point decline in the Dow Jones Industrials. Again, on May 5th following the Fed’s announcement, the Dow dropped by another 1,120 (3.3%), and the Nasdaq tumbled 5.2%, a level we haven’t seen since the height of the pandemic in 2020.
We encourage you to be mindful of the risks to the market, and reflect on your spending. If you’re withdrawing more than you should from your accounts, consider re-evaluating your needs. Bond funds are expected to bear substantial pricing challenges during periods of rising interest rates; consequently, they warrant constant evaluation. It is important to stay patient during turbulent times as buying opportunities may present themselves. If you have questions, please call our office and speak with your advisor. We’re here to serve you in both times of peace and prosperity and times like the present. Be well, and thank you for your confidence and your continued commitment to Ciccarelli Advisory Services, Inc.