We continue to see a significant deceleration in the incoming economic data, which raises the risk of recession. Inflation remains the major concern for consumers, businesses, and market participants.
The Federal Reserve (Fed) will be the focus of attention Wednesday, where they are expected to raise short-term interest rates by 0.75% in response to stubbornly high inflation. Comments on their inflation outlook will be watched closely since lower price pressures are needed for them to ease off their aggressive interest rate hiking campaign. Despite the loss of economic momentum, second-quarter earnings have been revised up, which is supporting stock prices. All of this is discussed below.
Economic Slowdown Continues
The Conference Board’s Leading Economic Index (LEI) fell 0.8% in June, its fourth consecutive decline, and down in five of the past six months. It was also worse than the consensus of a 0.5% decline, led by falling consumer optimism about future business conditions, a pickup in jobless claims, falling stock prices, and shrinking factory new orders. Since 1969, the LEI has peaked a median of 10 months ahead of recession. Most recently, it peaked in February, raising the risk of recession in late 2022/early 2023.
The S&P Global Flash U.S. Composite PMI (a timely business survey) dropped 4.8 points in July to 47.5 (below 50 signals a contraction), the lowest level since May 2020, as private sector activity shrank, with output declining in both services and manufacturing. The report noted that the loss of momentum across the economy was the worst since 2009, excluding the pandemic. Along with the deterioration in the leading indicator mentioned above, this suggests a rising risk of recession in the second half of 2022.
Of note, the survey showed price pressures were still historically elevated, but continued to ease off their cycle peaks. In services, cost pressures were the softest in six months, while charge prices rose at the slowest pace since March 2021. In manufacturing, cost and selling price pressures were the lowest since the first half of 2021.
Weekly jobless claims—a timely and accurate indicator—are also consistent with the economic slowdown narrative. Initial claims for unemployment insurance increased 7,000 last week, its third consecutive gain, to 251,000. It was the highest level in eight months, and 85,000 above the trough back in March. While the level of claims is still low historically, especially when normalized for the size of the labor force, the recent increase indicates that the economy is past peak labor demand.
Despite the recent loss of economic momentum and increased recession risk, a path for a soft landing that avoids recession still exists. The fundamental underpinnings of the economy are healthy and there is a lack of major financial imbalances typically associated with recessions. U.S. household debt is 34 percentage points below its 2008 peak while relative to net worth, household debt is at multi-decade lows. Pent-up demand for housing and autos still exists.
Importantly, the unwinding of pandemic and war-related dislocations should put inflation on a downward path in the coming months while longer-term inflation expectations remain contained.
Early Results from Earnings Season
Second-quarter earnings are holding up well, considering the recent loss of economic momentum. With about 22% of S&P 500 companies having reported, 63% are beating second-quarter earnings estimates (vs. 79% average of last 4 quarters) and 64% are beating revenue estimates (vs. 77%). Financials and Discretionary are notable drags for both Sales/Earnings beats. Sales and Earnings surprise for the S&P 500 were largely supported by Staples (4.0% and 10.1%, respectively), Health Care (1.5%, 7.7%), and Energy (9.8%, 4.8%).
Since the beginning of the earnings season, second-quarter 2022 earnings have been revised up 1.0% to $55.76 (+6%), though 2022 total earnings have been relatively flat at $228 (+10% y/y). This is a busy week for earnings with about 35% of S&P 500 companies reporting.
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