Stocks fell again last week and remain in a trading range with concerns centered on inflation, the Federal Reserve’s higher interest rate response, and the additional uncertainty caused by the Ukraine crisis.
While we acknowledge the headwinds facing the economy, economic indicators continue to suggest further economic growth will lead to higher corporate profits, which provide fundamental support for stocks.
Inflation Remains Major Concern
Inflation readings took center stage last week with consumer prices rising 1.2% month/month or 8.5% year/year. While high inflation was a problem before the Ukraine crisis, its impact is weighing heavily on energy (+11% m/m) and food (+1% m/m) prices. Together, they were responsible for 82% of the m/m increase and 40% of the y/y increase. Excluding food and energy, core consumer prices (+0.3% m/m, +6.5% y/y) moderated by more than expected and saw its slowest monthly gain since September 2021.
There are other early signs that inflation may be easing (used vehicles prices fell 3.8% m/m), but we expect inflation and uncertainty around it to remain a major concern through 2022. This uncertainty is now being aggravated by China’s lockdowns to contain the virus, which is impacting supply-chain normalization efforts.
While this suggests the Federal Reserve will remain diligent in raising interest rates this year, we don’t expect a sharp economic deceleration. Higher interest rates act with a significant lag and critical parts of the yield curve are not signaling recession. While we recently saw an inversion of the 2- to 10-year portion of the yield curve, the 3-month-to-2-year and 3-month-to-10-year portions of the yield curve have historically been better recession signals and they remain steep and consistent with further economic growth.
In addition, a still healthy consumer with over $2 trillion in excess savings, a historically healthy labor market, and pent-up demand should continue supporting the economy. Last week saw continuing jobless claims reach the lowest level since March 1970, while the insured jobless rate was unchanged at a record low of 1.1%. The low number of workers relying on unemployment benefits for income support is another sign of the strength of the labor market and supports our outlook for continued growth/no recession in the near term.
OECD U.S. Leading Indicator Continues to Signal Stable Growth
The OECD Composite Leading Indicators (CLIs) aim to anticipate fluctuations in economic activity over the next six to nine months based on a range of forward- looking indicators such as order books, confidence indicators, building permits, long-term interest rates, new car registrations, and many more.
The OECD U.S. Composite Leading Indicator (CLI) was unchanged in March, indicating near-trend growth at the end of the first quarter. The CLI has ground lower since the peak in May 2021, as fiscal stimulus wound down and the Federal Reserve started raising interest rates. While the Russia-Ukraine war has introduced more uncertainty about the outlook, the index remains consistent with further economic growth and is not sending a recession signal.
In the United Kingdom and in euro area as a whole, including Germany, France, and Italy, the CLIs anticipate growth losing momentum, driven by a contraction in consumer confidence indicators and the surge of inflation. Among major OECD economies outside the U.S. and Europe, the CLIs remain above trend and continue to signal stable growth in Japan and Canada. Among major emerging-market economies, the CLIs for China and India continue to point to stable growth, whereas in Brazil the CLI continues to anticipate slowing growth.
Earnings Season Starts
Earnings season started last week, and first-quarter expectations are for revenues and earnings-per-share growth of 10.8% and 5.1%, respectively. Excluding financials, which face tough comparisons after releasing significant pandemic reserves as earnings last year, results look to be much better with revenue and earnings expected to rise 12% and 14%, respectively.
With about 9% of the S&P 500 Index’s market capitalization reporting, earnings are beating estimates by 8.7% with earnings on pace to far exceed the 5.1% estimate. We expect earnings to continue providing support for stock prices, given our outlook for further economic growth.
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