Capital Markets Perspective brings you what to watch in the markets this week, published in partnership with Great-West Investments.
Week in Review
June 27-July 3
“Back when I was your age…”
If you were lucky enough to know your grandparents, you probably had that phrase fired at you like a verbal missile at one point or another during your childhood – usually when you were doing something stupid or obnoxious. The implication was that if your granddad had messed up as badly as you just did when he was a kid, there would’ve been consequences. But you, on the other hand, probably got off scot-free because the parenting environment has changed so radically between then and now (at least through the wise old eyes of your grandfather.)
At the risk of sounding like my own granddad, I think the market’s behavior through much of the first two quarters of 2022 probably qualifies for the phrase. Here’s what I mean: It’s certainly debatable whether markets are currently doing anything stupid (my take: the recent declines are not at all stupid given the uncertain economic backdrop,) but we’d probably all agree that from the perspective of those saving for retirement, the market’s misbehavior so far this year is at least obnoxious, if not downright mean. And at the same time, something about today’s environment is fundamentally different than in years past such that the implications of all this volatility just aren’t what they might have been during the bygone days when grandpa was saving for his retirement.
Take, for example, the relationship between stocks and bonds. Ordinarily, when stocks drop you expect bonds to perform relatively well; conversely, when stocks do well, your bond holdings are probably having trouble keeping up. This tendency of the investment world’s two primary asset classes to move in opposite directions of one another is the whole premise upon which the concept of diversification rests, and it’s often believed to be one of the most reliable relationships in modern finance.
Trouble is, it hasn’t worked very well here in the post-COVID environment. In fact, there has been almost no statistical relationship at all between U.S. large-cap stock returns and U.S. Treasury yields so far this year[1], and if anything, it kind of feels like bonds and stocks have been moving up and down together on a day-by-day basis, all to the frustration of a well-allocated portfolio.
The reason for this apparent disconnect isn’t exactly a mystery: what’s been pressuring stocks since the turn of the calendar is a dramatic, Fed-engineered increase in interest rates – the very environment that bonds also hate the most. Little surprise, then, that both stocks and bonds seem to have spent most of this year selling off together on the way down, then, at least once in a while, skipping happily higher hand-in-hand on the way up.
But that might be changing. Since the middle of June, markets seem to be behaving much more like they “should”: on days when stocks fall, bonds have been a little more likely to rise than they have in the recent past; and when stocks rise, bonds have been a little more likely to fall. Said another way, that relationship – the one that makes a diversified strategy work in the first place – seems to be re-asserting itself.
And that’s a good thing. Sure, we’d probably all sleep better at night if stocks always rose and bonds were always at least holding their own, but alas, the world doesn’t work that way. Investing, after all, involves risk, and when the environment gets a little shaky we’re probably all going to lose money for a little while. But eventually that uncertainty passes and the boring old relationships – like the tendency of bonds and stocks to move in opposite directions – reestablish themselves.
Said another way, today’s investment environment might (finally) be starting to look a little more like what it was during the B.C. (“before COVID”) era, back when me and your granddad were contributing to our 401(k)s. And that’s inherently comforting. At a minimum, this small return-toward-normal might suggest that the bear market – if that’s what this truly is – has begun to mature.
But let’s be clear: all this really means is that the reason for markets to trend lower may have changed (from a fear of dramatically higher rates to something more pedestrian, like a slowing economy), but it doesn’t necessarily mean that we’ve seen the last of the losses. Evidence that the economy is slipping faster and faster toward recession continues to mount, including a bunch of PMI-type data that was almost universally bad last week. Let’s start with the Dallas Fed’s Texas Manufacturing Outlook Survey (also known as the “TMOS”, or more simply, “the Dallas Fed.”) Like Empire State[2] and the Philly Fed[3] before it, the Dallas Fed was a wide miss, suggesting that the region’s manufacturing sector is beginning to contract as demand softens. Such was the message from the Richmond Fed’s version of the same report,[4] as well as the S&P Global/Markit PMIs that we got on Friday[5]. Perhaps most troubling, you’re starting to see phrases like “(the) manufacturing sector is acting as a drag on GDP, with that drag set to intensify” (S&P Global,) and “(the business outlook) is the lowest since May 2020” (Dallas Fed) make their way into the commentary. (For the record, May 2020 was when the pandemic was in full swing and we were all still cheering for healthcare workers from our patios.)
Almost on cue, the final revision of first-quarter economic growth was downbeat as well, with GDP growth now estimated to have been -1.6% during the first three months of 2022, a little weaker than first reported. The negative revision was a result of softer-than-reported consumer spending,[6] a message came through in the Bureau of Economic Analysis’ personal income report for May as well, with consumer spending falling to almost-flat and thereby missing estimates (while enduring a big negative revision of April’s numbers to boot[7]).
But softer consumer spending shouldn’t surprise anyone, because consumers have been telling pollsters how lousy the economy is for months now. We got further confirmation of that last week, when the Conference Board’s consumer confidence index[8] finally followed the University of Michigan’s sentiment survey lower.
If all this talk of economic storm clouds building has you depressed, take heart: there are seeds of sunshine in some of these reports as well. For example, most (but not all) of those weak PMI reports referenced above also mentioned that supply chain stress might be easing, whether in the form of rising inventories or improving vendor performance. And that’s a good thing for those worried about inflation because it suggests that one of the leading causes of inflation might be relenting a little bit. Not convinced? I don’t blame you, but that same income-and-outlays report referenced above that showed consumer spending was anemic in May also contained an update of so-called PCE inflation, which – while still elevated – was at least a little bit lower than expected. That’s relevant because the PCE price index is the Fed’s favorite way to measure inflation.
Which brings me to my last point for this week. Even if a moderation in the rate at which PCE prices are rising isn’t enough to convince the Fed to slow its roll just yet, markets seem to think we’re much closer to a time when the Fed might actually cut interest rates than we have been in a long time. To wit, futures markets are now seeing a fairly high probability that the Fed will be in rate-cutting mode as soon as next July[9].
That’s obviously not great news for those on “recession watch” because it implies that the economy will have cooled enough between now and then to force the Fed off its aggressive tightening stance and into easing mode. But to torture another metaphor, it also means we’re perhaps only about 12 months away from a time when the Fed will not only take its foot off the brakes, but to begin pushing the accelerator as well.
And markets would probably like that just fine.
What to Watch This Week
July 4- 10
Notable economic events (July 4–8)
Monday: U.S. markets closed for Independence Day
Tuesday: Factory orders
Wednesday: ISM/PMI services and composite, JOLTS, Fed minutes
Thursday: Challenger job cuts, ADP payrolls, weekly jobless claims
Friday: Non-farm payrolls
It’s payrolls week, together with all the associated fun that surrounds it. On Wednesday we’ll get the JOLTS (“job openings, leaving, and turnover survey”) which details who’s hiring, who’s quitting, and who has the upper hand in salary negotiations. On Thursday, the attention shifts to payroll processor ADP and its guesstimate of payrolls, followed by the BLS’ all-encompassing employment situation report on Friday, which includes all sorts of market-relevant data like the unemployment rate, labor force participation rates, average hourly earnings, and the headline number, non-farm payrolls.
But if you’re looking for a more bohemian (but potentially more impactful) look at current labor market trends, look to Challenger Gray and Christmas’ monthly tally of layoff announcements on Thursday. In my view, something fundamental is starting to shift within the labor market, wherein businesses are no longer quite as afraid to right-size their workforces as they were during and immediately after the worst of the pandemic. If, as the data strongly suggests, the U.S. economy is inching its way toward recession, the number of layoffs captured by this report should start to grow in the very near future. Because a softening labor market is one of the necessary pre-conditions for the Fed to calm down a little, an uptick in layoffs might ironically be viewed as somewhat market-friendly.
Speaking of the Fed, Wednesday will see the release of the Fed minutes from the FOMC meeting on June 14-15. That’s the meeting where the Fed surprised markets by bumping rates up by 0.75% instead of the 0.50% it had been promising for months. Details of the discussion surrounding that move could provide an unusually clear window into Fed thinking, which will obviously remain market-relevant for at least the next several months.
A little further down the list in terms of immediate potential impact are the service sector- and composite PMIs, due out Wednesday. The extent to which service sector PMIs have followed manufacturing PMIs lower will say a lot about how close the U.S. economy is (or isn’t) to falling into recession, and while that’s always interesting and important, recent market moves suggest that investors might already be looking ahead to a time when the economy is shrinking substantially and have begun to digest the implications. That moves the PMIs down by half a notch in my book, turning their importance away from a calculation of “when will the recession start?” to something more like “how deep will the recession be?” or, even further out, “when will the PMIs bottom out and suggest a return to growth?” It’s of course way too early to expect those messages to be embedded in this week’s data.
Finally, it’s worth remembering that we’re only about two weeks from the beginning of second quarter earnings season. My personal belief is that markets have largely moved beyond interest rates as a source of volatility and are now waiting for the next shoe to drop: namely, earnings. While a handful of miscellaneous companies will report results in the next two weeks, the season begins in earnest during the week of July 18-22. Between now and then, watch out for companies who hit the wires to revise guidance as the economy slows. If anything comes out of left field to change market sentiment in a meaningful way this week, I’d be willing to bet it would be revised earnings guidance from a marquee company or two ahead of Q2 reporting season. I guess we’ll see…
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Personal Capital Advisors Corporation (“PCAC”) is a wholly owned subsidiary of Personal Capital Corporation (“PCC”), an Empower company. PCC and Empower Holdings, LLC are wholly owned subsidiaries of Great-West Lifeco Inc. Source for index data: Bloomberg.com; GWI calculations.
[1] GWI analysis; data: Bloomberg
[2] https://www.newyorkfed.org/survey/empire/empiresurvey_overview
[3] https://www.philadelphiafed.org/surveys-and-data/regional-economic-analysis/mbos-2022-06
[4] https://www.richmondfed.org
[5] https://www.pmi.spglobal.com/Public/Home/PressRelease/2d28f20f99144f25bd47db453ee995a8
[6] https://www.bea.gov/news/2022/gross-domestic-product-third-estimate-gdp-industry-and-corporate-profits-revised-first
[7] https://www.bea.gov/sites/default/files/2022-06/pi0522.pdf
[8] https://www.conference-board.org/topics/consumer-confidence
