Mid-Year Reflections – C.J. Lawrence Market Commentary – July 18, 2022
This post was originally written on July 18, 2022, 1:22 PM EST.
Last week’s inflation data for June at 9.1% was a step in the wrong direction. As long as inflation surprises the upside, markets will have a tough time performing. Prices for energy, travel, and food continued to be elevated in June despite industrial commodities like copper and housing materials like lumber being down sharply from the March high. We are also seeing glimmers of hope in declining gasoline prices in July. Housing inflation, also known as “shelter” within CPI, peaked back in February and is up ‘only’ 5.6% in June. Supply chains for certain goods like grains are also starting to ease. Corn prices are down from $8.24 $/bu in April to $6.15 today. Wheat contracts are down from a high of $12.84 in May to $8.18 today. Used car prices, a key weight in CPI, have also begun to decline in July after still rising 4% in June. This gives us confidence that the ship regarding inflation may be turning. Tech stocks have begun to outperform the broader market in July. That is a good sign. Treasury yields for 10-year maturities remain steady at 3%, off the June 14th high of 3.5%. We published our mid-year letter last week.
Bonds offered little sanctuary with long-term U.S. treasury bonds (Bloomberg U.S. Long Treasury Index) down 21.3% and short-term U.S treasury bonds (Bloomberg U.S. 1-5 Year Government Index) down 4.2% in the first half of the year. Meanwhile, high-grade corporate paper (ICE BofA U.S. Corporate (A) Index) declined 12.8%, and U.S high yield (ICE BofA U.S. High Yield Index) fell 14.0% in the first half. Even gold (New York Mercantile Exchange Spot) finished lower in 1H22, down 1.2%, while the preponderance of crypto assets fell between 60%-80%, depending on the flavor.
After three consecutive years of S&P 500 double-digit returns and positive equity returns in eight of the last ten years, the S&P 500 looked poised for a cooling-off phase coming into 2022. Needing only a single catalyst to spark a drawdown, several emerged. Markets have been roiled by multiple headwinds, including surging energy prices, the raging war in Ukraine, Covid lockdowns in China, aggressive rate hikes by the U.S. Federal Reserve, and record-high inflation. The market narrative has vacillated between the need for the Federal Reserve to aggressively treat an overheating economy and inflation to fears of recession. Pundit opinions dot the landscape in between.
The US economy looks resilient, but signs of a slowdown are emerging. The “flash” US composite purchasing managers’ index (PMI) eased from 53.6 to 51.2 in June. The services component declined from 53.4 to 51.6, but the manufacturing output deteriorated from 55.2 to a two-year low of 49.6. Only twice has this measure fallen by more than 5.6 points; during the pandemic in 2020 and the financial crisis in 2008. PCE inflation, the Federal Reserve’s preferred price gauge, was unchanged at 6.3% yr/yr in May, while the broader Consumer Price Index (CPI), exceeded economists’ forecasts. The Federal Reserve is expected to raise the Fed Funds target rate by 75 basis points at each of its next two meetings, despite signs of economic cooling. The backdrop has created one of the most challenging investing environments in decades.
Coming into 2022, we had been trimming some of our multi-year winners and looking to redeploy capital into areas of the market where new technologies are being introduced but are not yet recognized or rewarded by investors. New additions in Q2 included stocks in the agriculture machinery and technologies, North American oil and gas productions and reserves, and healthcare services sectors.
We’re looking forward to putting the first half of 2022 in the rear-view mirror while acknowledging that the current investing environment continues to be challenging. The forward price-earnings ratio on the S&P 500 began the year at 21.6x and finished the first half at 15.9x. That is a meaningful move lower. Meanwhile, earnings and margin expectations were little changed during the period. The stock market may have to wrestle with the prospect of reduced profit expectations in the coming weeks and months, and that could create additional volatility. But while markets may vacillate, we remain steadfast in our conviction that owning shares of high-quality companies that innovate and grow market share leads to long-term investment performance. We are confident in our strategy and process, which has served our clients well for decades, and we are grateful for your continued confidence in us.