July marked the best month for the markets since November 2020.
What happened, after the rout of the first half? Some ideas:
The fly in the ointment? That pesky second quarter GDP contraction that could be interpreted as a sign that we are in or near a recession. But there is other, more positive data too.
Let’s get into the data:
Determining whether we are in a recession is the province of the National Bureau of Economic Research (NBER). They don’t just look at GDP, and they are very measured in calling a recession. Given a broader range of data, including increasing GDI (gross domestic income), strong labor markets, and continued (if slower) wage growth, it’s possible they could reach a conclusion we’re not in a recession.
This is the view of Fed Chairman Powell, from his remarks after the 75 basis point increase at the FOMC at mid-month. Even if we are in a recession, or if one is likely in the upcoming months, it could be mild and short. Chairman Powell telegraphed a likely 75 basis point increase in September but opened the “data dependent” door to potentially lower rate increases for the rest of the year.
The Fed is aware of the pain that fighting inflation is causing, but once it has achieved some “slack” in the economy – interpreted as lower employment – it may be willing to reassess future rate increases.
Remember, the Fed only has demand tools in its arsenal. It raises rates to lower investment, which puts downward pressure on growth, which impacts both jobs and wages, and eventually lowers inflation.
Inflation isn’t just demand-based. There is a big supply component, and that is still hostage to things like the money supply (which increased massively during 2020), the invasion of Ukraine and ongoing supply chain disruptions.
Chart of the Month: GDP vs GDI: The Trajectories are Diverging
Gross domestic income (GDI) paints an expansion picture, and GDP signals a contraction. Economists look at an average of the two. They are both subject to revision, which usually puts them back on a parallel path. Research from the Fed has found that since the 1990s, initial GDI growth estimates tend to predict eventual revisions to GDP.
Measures of Economic Growth
Equity Markets in July
Earnings results and guidance were a big part of the rally. As of month end, 278 issues have reported, with 209 beating estimates (75.2%) and 67.9% beating estimates on sales. Overall Q2 earnings are expected to post a 7.3% increase over Q1 2022.
The 10-year U.S. Treasury ended the month at 2.66%, down from 2.98% in June. At year-end 2021, this rate was at 1.51%. The 30-year U.S. Treasury ended July at 3.02%, down from 3.19%. The Bloomberg U.S. Aggregate Bond Index ended July with a return of 2.44% but is still down year-to-date with a return of -8.16%. The Bloomberg U.S. High Yield Index returned 5.90%.
The Smart Investor
The Fed uses the phrase “data dependent” to indicate that it will be revising its position on interest rate increases as the economy responds to the increases it has already enacted.
Fed Chairman Powell stated that the 25-basis point increase in March, a 50 basis point increase in May, and 75 basis point increases in June and July that have raised the Fed funds rate to 2.25%-2.50% may have created more economic slowing than is reflected in the current economic data. He termed it “in the pipeline.”
For the Fed, this means it may decrease rate increases if inflation declines and the job markets show more signs of loosening.
But what does that mean for you?
Think about three dimensions of wealth planning:
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