Weekly investment strategy

Review the latest Weekly Headings by CIO Larry Adam.

Key Takeaways

• S&P 500 won’t notch its 7th consecutive positive summer
• The markets were too quick to price in rate cuts
• Resilient earnings boosted the mid-summer rally

As Labor Day, the ‘unofficial’ end to summer, draws near, investors have either returned from or are taking the last of their well-earned summer vacations. Meanwhile, the equity market has done some traveling of its own. The S&P 500 is only 3.5% below its Memorial Day level, but there’s much more to the story. At the start of the summer, the Index rapidly fell into bear market territory (e.g., a decline of more than 20%) with the S&P 500 declining ~24% from its January record high. Then, despite depressed sentiment, it notched an impressive 17.4% rally—lifting optimism that the S&P 500 would notch its seventh consecutive positive summertime return. But weakness over the last two weeks (-7.9%) sadly caused that streak to be broken. But not all is lost as we learned seven valuable insights about the economy and financial markets that help us construct our views for the remainder of the year.

1. The Shift From Goods To Services | The ‘Summer of Revenge Travel’ was not a misnomer. Despite elevated travel-related prices, TSA screenings skyrocketed to multi-year highs, hotel occupancies improved, and restaurant bookings reached above pre-pandemic levels. While early trends suggested that consumers felt safe returning to travel, the further easing of restrictions (e.g., testing requirements) fueled the desire to travel more. On the flipside, many mass retailers underestimated the seismic shift from goods-based spending to services, resulting in bloated inventories, some 20-40% above pre-pandemic levels! As a result, sales and discounting became more common as the summer wore on (a good omen for inflation).
2. The Difference Between A Real & A Technical Recession | The US economy posted two consecutive quarters of negative growth (-1.6% in Q1 and -0.6% Q2), eliciting headlines that the US economy was in recession. We disagree. Why? Because the biggest contributor to GDP—consumers—continued to spend and remained additive to GDP. Whether it was bustling vacation travel or record setting ($12 billion) Amazon Prime Day sales, the consumers’ ability and willingness to spend is robust. And with the job market healthy (11.2 million open jobs!) and $2 trillion in excess savings, the consumer remains well-positioned.
3. Peak Inflation Is Behind Us | The July inflation report provided the first evidence that inflationary pressures may be at an inflection point and set to decelerate from the highest levels since the early 1980s. Much of the cooling at the headline level was driven by gasoline prices retreating from their $5.02/gallon peak to under $4/gallon. In addition, given that economically-sensitive commodities have fallen (e.g. copper down ~28% from its peak), inventory levels remain bloated and food prices are likely to ease in 4Q, we’re confident that inflation will continue its downward trajectory into year end and beyond.
4. Markets Were Too Quick To Price In A Pivot | Chairman Powell’s commentary at the Jackson Hole Symposium caught the markets by surprise. Market expectations were reflecting 50 basis points of interest rate cuts in 2023. But with inflation yet to show a consistent pattern of deceleration, the Fed reminded markets that the tightening cycle is not yet over. In our opinion, this rhetoric is setting the stage for the Fed to raise interest rates by an additional 1% by year-end, before easing inflationary pressures allow the Fed to go “on hold” for an extended period with a target rate of 3.50% through 2023.
5. This Quantitative Tightening Cycle Won’t Be Like The Others | The unwinding of the balance sheet is set to ramp up in September—with the Fed increasing its reduction pace from $47.5 billion to $95 billion per month. Given that it is coinciding with the most aggressive tightening cycle in 20 years and that tightening is occurring globally (e.g., Canada, Europe, UK), Treasury market liquidity will likely be challenged, and bond market volatility will likely be elevated in the months ahead.
6. The Stage Is Set For The Midterms | Recently, prospects of a Congressional Republican sweep at the midterm elections have been dampened. With economic expectations (e.g. inflation) and President Biden’s approval rating improving, Predictit has the probability of the Republicans winning the Senate below 50% (currently 40%) for the first time this year. However, the probability of the Republicans winning the House is ~75%. As a result, a split Congress outcome is growing.
7. Earnings Were Better Than Feared | Robust 2Q22 earnings and sanguine corporate guidance were not consistent with the recessionary conditions that headlines were insinuating—especially in regards to resilient consumer spending patterns. While 2Q earnings growth of 7% was not nearly as impressive as the double-digit quarters we saw through 2021, the upside surprise helped the S&P 500 rally 14% from the ‘unofficial’ start (big banks reporting) through the unofficial end (the big box retailers) of the reporting season—the best earnings season performance since 1Q97. Positive earnings growth should support equities.For more insights on the above topics and more, please join us for our next Investment Strategy Webinar titled

   ‘Kickin’ The Sand Out Of Your Shoes” on September 12 at 4PM EDT. To register visit: https://go.rjf.com/WEB922

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