Market Note – August 1, 2022

By Hightower Great Lakes on August 1, 2022

Sequential Negative GDP Prints

Last Thursday, the Q2 GDP preliminary report showed -0.9% q/q, following -1.6% q/q contraction in Q1. While some may classify this as a recession, Fed Chair Powell was clear on Wednesday that he did not think the U.S. economy is in a recession, citing “too many areas of the economy that are performing too well” and specifically highlighting the labor market strength.

Low unemployment rate, rising income and healthy household spending all seem to contradict the technical definition that two sequential periods of negative GDP represents a recession.

A deeper dive into the Q2 GDP print showed a decrease in inventory investment detracted from GDP, while consumer spend contributed to 0.7% GDP growth. Interestingly, consumer spend on services rose 4.1% while the goods segment declined by 4.4%.

This is consistent with the consumer wanting to spend on experiences post COVID – many companies including Imax (IMAX), Wells Fargo (WFC), Marriott (MAR) have also reiterated this point.

The National Bureau of Economic Research (NBER) will determine when the U.S. economy is in a recession. NBER is a nonprofit, non-partisan organization, and its committee consists of eight economists. NBER’s definition of recession is “a widespread contraction in the economy that lasts for more than a few months.”

NBER may not make a decision for many months, and whether or not the economy is in a recession, it’s clear that a slowdown is occurring. This is because of the reversal in fiscal and monetary stimulus along with above-average inflation.

Q2 Earnings Update

Q2 Earnings Update. With over 72% of the S&P 500’s market cap already reported, 71% of companies have topped earnings projections and they’re on track for 9.6% y/y EPS growth.

EPS growth is being driven by value names whose earnings are, on average, +16.7% y/y vs. growth names, whose earnings are, on average -1.8% y/y. Value companies have outperformed estimates by 5.8% vs. 2.6% for growth companies.

There was concern ahead of earnings season for slowing profits in Q2 and a cautious growth outlook. While Q2 downward revisions were relatively muted leading up to earnings season, revisions are taking form for second-half expectations.

Based on updated second-half outlooks and guidance, full-year EPS growth expectations have fallen from June’s peak estimate of +10.3% y/y to the latest estimate of +8.7% y/y. Last week, according to FactSet, analysts revised full-year EPS downward for 57% of companies in the S&P 500.

Energy has surprised the most to the upside, beating earnings estimates by +12.6%, followed by utilities beating by +9.1% and health care beating by +9.0%. Communication Services is the only sector to report a negative aggregate earnings surprise, of -0.2%.

The Fed Commits to Data Dependency, Restraining from Guidance

As was widely expected, the Federal Reserve hiked its target rate another 75 bps at last week’s meeting as it continues to fight the highest inflation readings in four decades. Fed Chair Powell will no longer be offering guidance as he has previously done, and the Fed will remain dependent on incoming data, primarily the U.S. Personal Consumption Expenditure (PCE).

On Friday, the Core PCE Index and Employment Cost Index (ECI) still showed signs that inflation remains high. June Core PCE reported +4.8% y/y, while Q2 ECI reported +1.3% q/q – both slightly higher than expected.

The Fed generally uses Core PCE data as the best way to capture the inflation picture, and their goal is for that number to be 2% y/y. Clearly, there is more work to be done on higher rates. And we’ve argued that it will likely remain elevated for quite some time given the sticky nature of higher wages and rents as well as education and health care.

Leading up to and following the Fed’s rate hike announcement, Treasuries rallied, driving the 10-year yield to 2.63%, the lowest since April. The 3-month/10-year spread is now sitting at +23 bps, and the possibility of its recession-signaling inversion continues to linger.

Municipals also rallied throughout the week, with yields falling 10-19 bps across the curve – with the largest moves in the belly. Corporate spreads tightened throughout July; Investment Grade finished the month at +166 bps, and High Yield at +510 bps.

The Fed’s next major event is the annual Jackson Hole Economic Symposium, taking place August 25-27, and their next FOMC meeting is in September. We expect the focus for investors will be on the upcoming CPI, PPI and other inflation metrics within the ISM reports, along with Core PCE and the Employment Cost Index. In fact, today the ISM Prices Paid Index came in lower than expected for July – an encouraging sign.

Congress Gets Busy: CHIPS Act, Inflation Reduction Act

America’s largest chipmaker, Intel Corp. (INTC), is set to benefit, along with a number of other chip manufacturers, from U.S. government subsidies that will encourage chipmaking in the U.S. Officially dubbed the CHIPS and Science Act, this bill is designed to reduce reliance on Asia for critical semiconductor equipment and manufacturing, creating U.S. jobs and improving U.S. security.

Shortly after its passing, Micron (MU), announced its decision to bring manufacturing to the U.S. The bill includes $39 billion in grants for new manufacturing, $11 billion for federal semiconductor R&D programs and $2 billion for the Defense Department.

Another bill, the Inflation Reduction Act, is in Congress’ reconciliation process and, if passed, will invest more than $400 billion over the next decade toward business-tax reform, health-care cost reduction programs and fighting climate change.

While its impact on inflation is being hotly debated, its climate change package would incentivize production of low-carbon fuels, supporting increased supply of clean energy.

The Week Ahead

Earnings – Monday: SPG. Tuesday: CAT, MAR, CMI, FANG, CF, AMD, PYPL, SBUX. Wednesday: CVS, MRNA, CTRA, OXY, FTNT, EBAY, MGM. Thursday: APTV, APD, JCI, PARA, ZTS, ALL, LLY, K, APA, COP, EXPE, AMGN, LYV. Friday: BRK.B, WAB, EOG, CTVA.

Economics – Monday: ISM Manufacturing PMI (July). Tuesday: JOLTs Job Openings (June). Wednesday: ISM Services PMI (July), OPEC Meeting. Thursday: Initial Jobless Claims. Friday: Unemployment Rate (July), Nonfarm Payrolls (July), Average Hourly Earnings (July), Participation Rate (July).

Return for Selected Indices²

		% Change
Index Name	End of Week	Week	Month	YTD
S&P 500 INDEX	4,130	4.28%	8.28%	-12.59%
NASDAQ COMPOSITE	12,391	4.72%	10.89%	-20.45%
DOW JONES INDUS. AVG	32,845	2.97%	5.96%	-8.60%
RUSSELL 1000 INDEX	2,267	4.20%	8.29%	-13.59%
RUSSELL 2000 INDEX	1,885	4.35%	9.72%	-15.45%
FTSE 100 INDEX	7,423	2.06%	1.65%	2.61%
HANG SENG INDEX	20,157	-2.20%	-7.90%	-11.79%
NIKKEI 225	27,802	-0.40%	3.73%	-2.37%

				% Change
Index name	YTW	Spread	Duration	Week	Month	YTD
U.S. TREASURY	2.89%		6.51	0.29%	2.06%	-7.69%
U.S. AGGREGATE	3.42%	+53 bps	6.62	0.64%	2.87%	-8.16%
U.S. CORPORATE INV. GRADE	4.33%	+144 bps	7.86	0.50%	3.48%	-11.61%
U.S. CORPORATE HIGH YIELD	7.73%	+484 bps	4.67	1.53%	5.49%	-9.12%
U.S. MUNICIPAL BOND INDEX	2.79%		5.49	0.92%	2.94%	-6.58%

Click here to read last week’s Market Note (7/25).

SOURCES

¹ Source: NPR
² Source: Bloomberg

Disclosures

OCIO is a group of investment professionals registered with Hightower Securities, LLC, member FINRA and SIPC, and with Hightower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through Hightower Securities, LLC; advisory services are offered through Hightower Advisors, LLC.

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