Macro matters.
We now have two consecutive quarters of negative GDP growth after Q2 GDP came in at -0.9%, the historical definition of a recession. Whether the eight economists at the National Bureau of Economic Research (NBER) Business Cycle Dating Committee officially coin it a recession or not is less clear. Despite the weakness in GDP growth, the strong labor market is bucking the typical recessionary trend evidenced by 3.6% unemployment and 375K jobs/month payroll growth in Q2. Economists will keep a close watch on the labor market to assess the effectiveness of the Fed rate hikes on the inflation front. Any weakness in initial jobless claims will act as proof that the Fed’s action are a necessary sacrifice to labor demand, a key factor for making progress to get inflation under control.
Market pivot.
During the July FOMC meeting, Jerome Powell indicated that the Fed’s future rate decisions will be taken “meeting by meeting.” The market’s interpretation seemed to be that they may slow the pace of hikes in the back half of 2022 and may be forced to eventually reverse course. This is based on the further inversion of the treasury curve, a closely watched recessionary signal, and the subsequent stock market rally that ensued.
The +9.2% July 2022 advance in the S&P 500 marks the best month since November of 2020 for the large-cap stock index. Small and mid-cap stocks followed suit, up over 10% on the month. Several factors such as the ongoing war, US dollar strength, and China’s troubles weighed on the performance of foreign and emerging market stocks which were up +5.0% and down -0.2%, respectively. Growth stocks mounted a comeback against value stocks this month, and tech stocks rallied off the lows thanks to the potential for a Fed pivot.
Earnings season has been mixed, but generally better than the anticipated disaster scenario that was priced in June. Fears quickly eased thanks to a few large tech companies that have reported strong results. Future earnings estimates have been revised slightly lower, but it remains a wait-and-see environment.
Final thoughts.
The “bad news is good news” market rally has been a welcome change in the short term. The longer-term challenges of a slowing economy and stubbornly high inflation still lie ahead. A lot will have to go right before the Fed can declare victory. For now, the focus will be on the key economic data related to the labor market.
