July 2022 Stonemark Market Commentary

Equity markets started the 2nd half of 2022 with a positive month all around. The NASDAQ led the rally with a 12.35% gain, followed closely by the Russell 1000 Growth, which added 11.94% during the month of July. The S&P 500, Dow Jones Industrial Average and the Russell 1000 Value all saw single-digit gains of 9.11%, 6.73% and 6.48%, respectively as Wall Street looked to rebound from a very ugly 1st half of the year.

All of the major averages ended the month in positive territory with the Consumer Discretionary (+18.90% for the month of July) and the Information Technology (+13.48% for the month of July) sectors leading the broader markets higher. While still positive, the Consumer Staples (+3.13% for the month of July), Healthcare (+3.18% for the month of July) and the Communication Services (+3.51% for the month of July) sectors were the laggards for the month.

Towards the end of July, the Federal Reserve (“the Fed”), in-line with market expectations, raised the targeted range for the Federal Funds rate (“Fed Funds rate”) by 75 basis points (“bps”) to a range of 2.25-2.50%. Members of the Federal Open Markets Committee (“FOMC”) cited sustained inflation risks, which, among other things, are being driven largely in part by the ongoing Russia-Ukraine war. Looking at the graphic below, according to the CME Group’s FedWatch tool, markets are pricing in a 72% probability that the Fed raises interest rates just 50bps at the September meeting, which would bring the targeted range to 2.75-3.00%. Additionally, by the end of the year (after September’s anticipated 50bps rate hike), markets are pricing in just another 50bps worth of interest rate hikes with 25bps coming at the November meeting and 25bps coming at the December meeting, which would bring the targeted range to 3.25-3.50%.

What is arguably more noteworthy than the expected upcoming rate hikes is what is happening next year. By the middle of next year, markets are currently pricing in two 25bps interest rate cuts to a targeted Fed Funds rate of 2.75%-3.00% (brown column in the graphic above). According to the CME Group’s FedWatch tool, market participants are forecasting that the final rate hike for the current tightening cycle will come in December of this year (yellow column in the graphic above), followed by no action at the February and March meetings (light blue and green columns in the graphic above, respectively), then followed by 25bps rate cuts at the May and July meetings (orange and brown columns in the graphic above). That being said, this data should be taken with a grain of salt. As we have noted before when using data from the FedWatch tool, these probabilities are set by traders who are actively trading futures contracts for where they expect the Fed Funds rate to be at a given point in time and can be quite volatile as certain economic data is released. Ultimately it is the Fed who sets the targeted range for the Fed Funds rate, which they do in accordance with maintaining their two stated mandates of price stability and full employment. While employment may be strong, price stability remains completely disconnected from the Fed’s 2% inflation target. As measured by the consumer price index (“CPI”), which is a monthly report that measures the price movements of a basket of goods and services, inflation for the month of June (which we received on July 13th) came in at 9.1%, the highest reading in more than 40 years. As a result of continued soaring inflation and very little evidence that the previous interest rate hikes have done much in the way of curbing inflation, we would expect the Fed to continue to raise interest rates at least at every meeting for the rest of the year and potentially into next year.

With the end of July wrapping up, according to FactSet, 87% of the S&P 500 companies have reported their 2nd quarter earnings results with 75% of those companies beating their EPS estimates. However, despite a significant percentage of S&P 500 companies beating their earnings estimates, as of the end of July, FactSet reported the blended earnings growth rate for the 2nd quarter of 2022 as 6.7%. FactSet’s calculation for the blended earnings growth rate was a combination of the actual earnings growth rate for companies who have reported and the forecasted earnings growth rate for companies who are yet to report. Should 6.7% be the final blended earnings growth rate for the 2nd quarter, this would mark the lowest earnings growth rate for the S&P 500 since the 4th quarter of 2020. As the graphic below indicates, between March 31st and August 19th, analysts over at CFRA have been forced to revise their 2nd quarter earnings estimates to the downside for 5 out of the 11 S&P 500 sectors but have maintained positive earnings revisions for the S&P 500 as a whole.

While 2nd quarter earnings for the S&P 500 as a whole are still being revised to the upside, CFRA’s analysts have in fact started to revise full-year 2022 earnings to the downside with analysts now forecasting full-year 2022 earnings to come in at $224.16 compared to $225.89 that they were expecting at the end of the 1st quarter. While the revision isn’t huge in terms of dollar or even percentage amounts, it is significant to note that this is the first time this year that CFRA’s analysts have been forced to revise their full-year earnings estimates. As we head into the 2nd half of 2022, we will have to wait to see if these earnings estimates continue to be revised lower. With several of the largest companies in the S&P 500 continuing to cite inflation as an increasing headwind on their earnings results, we will be eagerly waiting to see if this year’s cycle of raising rates starts to ease inflation or if inflation will continue to be a major obstacle as we head into 2023.

In May and June’s Monthly Commentary, we pondered the idea that we might already be in a technical recession given the fact that equity markets were selling off significantly, inflation was continuing to come in at record levels and the housing market was starting to cool off. Well, at the end of July we received the preliminary print for the 2nd quarter gross domestic product (“GDP”), which came in at -0.9%, almost a 1.5% difference from the 0.5% growth that economists were forecasting. Among the economics community, it is widely adopted that a recession is defined as two consecutive quarters of negative economic growth (as measured by GDP), so a -0.9% print that followed a 1st quarter GDP read of -1.6%, by all accounts is a technical recession. However, whether it is an attempt to hide the fact that we are indeed in a technical recession or we are now just completely changing the definition of a recession, economists are now arguing that we cannot possibly be in a recession. They argue that despite record inflation, with initial jobless claims hovering around the 230,000-260,000 level since the June 3rd reading, nonfarm payrolls holding steady above 350,000 and the unemployment rate sitting below 4% since January, there is no way we are in a recession, but that doesn’t mean one might not be on the way.

Looking at the graphic above, dating back to the beginning of 1970, just about every time we have seen inflation start to uptick like it has been for the last year or so, we have either been in the middle of a recession or one followed very shortly after. While the graphic does show that unemployment tends to be much higher than it is now, the most recent recession prior to the short-lived, COVID-19-induced “recession” of 2020 was the ’08-’09 Global Financial Crisis, which saw unemployment bottom out at just above 4%.

However, it is important to bring up a couple of trends that we are just now starting to see in the labor markets, which is an uptick in the number of layoffs that we are starting to see. Towards the end of last month, Canadian-based cloud commerce platform, Shopify (SHOP), announced that it was laying off 1,000 employees or roughly 10% of its workforce. As soon as that news broke, shares of SHOP were immediately down over 15%. Shopify was the first major company to announce such a significant layoff of its workforce, however, they were not the last. Both publicly traded and privately-held companies are starting to lay off employees, with some of those being quite significant. Some of the most notable companies include the following:

In addition to companies laying off employees, several companies have announced that they would be temporarily suspending all hiring as these companies attempt to cut costs in order to help out their bottom line. Most notably, Meta Platforms (META) and Google-parent company, Alphabet (GOOGL and GOOG) announced that they were freezing hiring for a period of time. Meta CEO, Mark Zuckerberg announced earlier this year that the company was halting hiring for new positions on almost every team within the company for the rest of 2022. Alphabet announced on July 19th that they would be freezing all hiring for two weeks. Alphabet’s announcement came just a week after they announced that they were going to be slowing down their hiring process for the remainder of the year as they seek to revamp and reassess their overall hiring process. With that said, if the unemployment rate remains at the current level or if we start to see an uptick in the unemployment rate, we believe that it would be very difficult to argue that we are not currently in a recession.

On the other hand, Fidelity Investments has a slightly different take on the current state of the economy and whether or not we are in a recession or bound for one. Fidelity presented the graphics below in their most recent quarterly market research update that shows a few things. First of all, very rarely does the Fed hike rates by this magnitude in a 12-month period. Secondly, when the Fed does hike interest rates by this much, GDP has tended to expand.

As it currently stands, the Fed has raised interest rates by 225bps so far this year, which means that, based off of the graphic above, when the Fed has hiked by this much historically, GDP expands 90% of the time during the current year and 86% of the time during the following year. However, we do not anticipate the Fed ending here. If the Fed gets to their targeted range of 3.25-3.50% by the end of the year, which we discussed earlier in this commentary, that will mark a 325bps increase, which still puts the odds of a current year and following year GDP expansion at 80% and 60%, respectively. As always, this is historical data and given the fact that the current market and current economy is far from normal, this needs to be taken with a grain of salt.

With 2nd quarter earnings behind us for the most part, our focus now turns towards the 2nd half of the year where there are still several market moving catalysts on the horizon. Next on the calendar is the Jackson Hole Economic Symposium, which will take place in Jackson Hole, WY from August 25th-27th. This year’s iteration of the global economic conference will highlight the economic constraints of the pandemic and the resulting supplychain constraints. Historically, aside from what is on the agenda for the annual conference, Wall Street has always used Jackson Hole as a gauge for what the Fed might do at the upcoming FOMC meetings. While investors will certainly be keeping an eye on Jackson Hole for what the Fed might do at the September, November and December meetings, we believe that Wall Street seems to have a pretty good idea of the Fed’s next move. In addition to Jackson Hole, we will also receive one or two more CPI prints before the FOMC’s next meeting on September 21st. While we are fairly confident that the Fed will raise rates by 50bps at the September meeting, we do believe that the Fed will be “data-dependent”. Lastly, as we enter the fall months, we will begin to start hearing more and more about the mid-term elections as we close in on November. With Democrats holding the slimmest of majorities in the Senate and a bit more of a comfortable majority in the House of Representatives, November’s mid-term elections will be some of the most highly watched races in recent memory as they will determine how the next two years of President Biden’s presidency turns out. With plenty of high-profile events on the horizon, we will continue to monitor any and all catalysts. Over the recent months, we have been raising our cash levels across all of our portfolios as some of these signs of market weakness start to flash warning signs. In the coming months, we have the ability to continue to raise our cash levels, sit where we currently are or redeploy our cash into positions that we already own or have been approved by our investment committee. Regardless of what the next 6 months and beyond have in store for the markets, we will maintain our diligence when it comes to the positioning of our portfolios.

As always, please feel free to reach out with any questions or concerns.