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August 2022 | Equity Commentary

August 2022 | Equity Commentary

Published on September 8th, 2022

Market Overview

Last month, we suggested that equity markets seemed too optimistic about the future path of monetary tightening. Futures markets were forecasting the Federal Reserve would actually begin cutting rates by next summer, an assumption explicitly at odds with what Federal Reserve officials were communicating publicly. Nevertheless, markets appeared to rally all summer on the idea that some combination of easing inflation, a weakening economy, and rising unemployment would prompt the central bank to eventually reverse course. A hawkish 8-minute speech by Federal Reserve Chairman Jerome Powell in Jackson Hole quashed these hopes and sent equities tumbling on the final days of the month. The S&P 500 erased early August gains to finish the month down -4.1%, and the weakness in bond markets that has persisted all year continued, with yields on 1-, 3-, 5-, 10-, and 30-year U.S. Treasury bonds all rising during the month, closing above 3%. 

At the annual gathering of central bankers in Jackson Hole, Wyoming, Federal Reserve Chairman Jerome Powell gave a speech that lasted less than ten minutes but has been impacting equity markets for several days since. Chairman Powell reiterated the Federal Reserve’s commitment to “a restrictive policy stance for some time,” but market consternation appeared to be tied to the statement that the Federal Reserve would “keep at it [rate hikes and tightening] until the job is done.”1 Powell’s references to the Volcker Fed, which notably pursued and even welcomed an economic recession in order to tamp inflation, in our opinion, made it even more clear to market participants that the “Fed put” was off the table.

At this stage, we believe the most the financial market may be able to hope for is a 0.50 percentage point increase at the September FOMC meeting, potentially slowing to 0.25 percentage point increases in future meetings, versus additional 0.75 percentage point increases. This has created an environment where ‘good news is bad news,’ particularly with regards to the US labor market. Since the Federal Reserve is sensitive to wage growth and its impact on inflation, a stubbornly tight jobs market is counterproductive to the Federal Reserve’s objective.

The August payrolls report did not help. The Bureau of Labor Statistics reported that the US economy added 315,000 new jobs for the month, which is only slightly lower than the previous six-month average of 381,000 new positions per month.2 It was slightly encouraging that monthly wage growth eased in August, with hourly earnings for private sector workers rising 0.3% month-over-month, and 5.2% from a year earlier. But this modest wage growth was coming off an acceleration in Q2, when wages grew at 1.6% versus the 1.3% growth posted in Q1.2

One bright spot is that approximately 786,000 potential workers entered the workforce last month, which improved the labor participation rate to levels (62.4%) not seen since March 2020.2 More workers can boost economic output, but they can also remove some of the wage pressures that stem from a tight labor market. We believe additional workers may have no trouble finding a job, as the ratio of job openings to unemployed people is the highest it’s been since the Labor Department started keeping records. Overall, in our opinion, the US jobs market remains in solid shape, which many would argue is good news for the economy but bad news for Federal Reserve policy.

What matters above all is whether inflationary pressures are starting to abate. July’s Personal Consumption Expenditures (PCE) price index, which is the Federal Reserve’s preferred measure of inflation, fell by 0.1% month-over-month and decelerated to 6.3% year-over-year from June’s levels.3 Falling gas prices were a key factor in the decline, and dozens of goods included in the index have shown evidence of peaking. Food prices continued to rise, however, up 1.3% month-over-month.3

Another important inflation metric is the ‘prices-paid index,’ which the Institute for Supply Management measures via surveys of US manufacturers. Encouraging signs of moderating inflation pressures emerged here as well, with the prices paid index falling from 60.0 to 52.5, its lowest level since late 2020 and well below the March 2022 peak of 87.1. Easing supplier delivery times and order backlogs also suggested that supply chain pressures were abating, which over the past year had been a major factor in driving prices higher.

On the services side of the US economy, it is somewhat unclear whether August was a month of expansion or contraction. The Institute for Supply Management reported that the services sector grew at a faster pace in August compared to July, with a reading of 56.9 versus 56.7, respectively.4 The data firm S&P Global offered a different take, stating that the services sector actually contracted in August due to falling demand. Their Services PMI Business Activity Index showed a 43.7 print for August, down from 47.3 in July and marking the fastest deceleration since May 2020.5 These conflicting readings of US economic activity are emblematic of the challenges in understanding exactly where the US economy is in this cycle, which we believe may be best described as plateauing versus contracting. 

A final note to mention is that China’s economy is in a notable slump, with data in everything from factory activity, consumer spending, and housing all in decline. The worst heat wave in 60+ years, a drought, and ongoing Covid-19 restrictions have all served as stiff headwinds to China’s economic growth. In particular, the heat wave and drought resulted in electricity shortages which curtailed manufacturing activity. Property developers in China are also reporting a plunge in activity, with sales off more than 30% compared to August 2021.6 The services sector has been hanging on, however, with China’s nonmanufacturing purchasing index slightly in expansionary territory with a 52.6 print in August. Services now make up 53% of China’s economy.7

Source:

1https://www.federalreserve.gov/newsevents/speech/powell20220826a.htm

2https://www.bls.gov/news.release/pdf/empsit.pdf

3https://www.bea.gov/news/2022/personal-income-and-outlays-july-2022

4https://www.ismworld.org/supply-management-news-and-reports/reports/ism-report-on-business/services/august/

5https://www.pmi.spglobal.com/Public/Home/PressRelease/c99346fb0f424ff291acbf2598a1bda0

6https://www.asiafinancial.com/china-home-sales-fell-for-14th-month-in-a-row-wsj

7http://www.stats.gov.cn/english/PressRelease/202209/t20220901_1887830.html

As of August 31st, 2022

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