What could have been a difficult week for stocks, turned into the best week the markets have had in some time. We entered this week with earnings announcements from some of the largest and most influential companies on deck, the announcement of the next Federal Reserve interest rate hike, and the first report of GDP in the second quarter. By the end of the week, the tide had turned and it was clear that the news, while not great, is not as bad as experts had predicted and enough to cause investors to dip their collective toe back into the water. While it is unclear if this enthusiasm will continue, we should take a minute to breathe a sigh of relief and enjoy the moment.
It’s hard to know where to start. There is so much to discuss and so little space to write about it. Let’s begin with the Federal Reserve’s interest rate hike since it is most responsible for the move higher in the markets this week. It wasn’t the hike, per se, but the comments from Chairman Jerome Powell that came after. In his press conference, he let slip that he believes, and by extension, the FOMC believes, that we are now at the “neutral” rate. In layman’s terms, he’s saying that the current interest rate hike puts interest rates at a point where they neither hinder nor help the economy. This was interpreted as dovish since it suggests that they are reaching a point where smaller moves make sense as policy gets more restrictive. Based on the market’s reaction, he might as well have said mission accomplished. That’s not to say we don’t expect further rate hikes, just that they will likely be smaller going forward. The next FOMC meeting is in September.
On the earnings front, earnings announcements have been coming in better than expected, albeit at a slower growth rate. Let me explain. As of the start of this week, one-in-five S&P 500 companies had reported. Of those, 68% have topped expectations which is great. There are, however, two caveats. Expectations have come down significantly in the past month, and the five-year average of the number of companies beating is 77%. I’d like to see this as the glass being half full. And clearly, investors this week saw it this way too. Namely, expectations have fallen too far and companies beating, even by a small margin, are being lauded as having triumphed last quarter. At the end of the day, the pendulum swung too far toward pessimism and is now beginning to swing back in the opposite direction.
What we hear on the conference calls and in the earnings announcements, is that inflation continues to be a headwind, as are constrained supply chains, and that the strong U.S. dollar is beginning to have a negative impact on both sales abroad and currency conversion back to the U.S. dollar. The strong dollar has wiped out billions of dollars off the second-quarter sales of U.S. companies, prompting many to cut their guidance for the remainder of the year. The currency issue has muddled an earnings period that is being closely studied for signs of a weakening global economy, as high inflation and tighter monetary policy weigh on business and consumer demand. Economic data are already signaling a pullback in activity, as inflation cuts into consumers’ real spending power.
As for the economic data, it is weakening. This shouldn’t come as a surprise, since it is exactly what the Federal Reserve is trying to accomplish. An overheated economy led to historically high inflation, so it only stands to reason that slowing economic activity should bring inflation down. I say should because some prices are stickier than others, particularly wages and rents. However, substantiating this slowdown is the decline in Q2 GDP for the second consecutive quarter. This could be called a recession, but probably won’t be due to a host of mitigating circumstances, such as the low unemployment rate and steady state of initial jobless claims. Even if it is determined we’re in a recession, it won’t become official until six months from now, at which point the economy will likely already have stabilized. For now, good news is great and slightly better than expected bad news is good. Don’t question it. It’s not worth the mental energy to try and unravel the doublespeak.
In closing, let’s talk about electric vehicles (EVs) for a minute. You no doubt either know someone who drives one or may be considering one for yourself. Their popularity is growing even if the technology leaves some with range anxiety. The question always comes down to whether to buy or lease a vehicle. Complicating this decision, Ford announced last month that it will stop giving customers the option to purchase their EV at the end of the lease as part of a policy to promote EV battery recycling and sustainability. Customers must return the vehicle when the contract is up and can then renew their lease with a new vehicle. The new rule applies to leases that began after June 15 in 38 states. However, this raises many questions. Is it environmentally friendly to force people into new cars every three years? Aren’t EV batteries supposed to last ten years on average? Is it sustainable to make cars disposable? Is it really a lease if I can’t buy the car or am I just renting it for the term of the contract? And lastly, is this just another money grab posed as something great for the environment? I don’t have answers, but it’s worth pondering. Now you know.Bruce J. Mason, MBA