June 2022 | Equity Commentary
Published on July 8th, 2022
U.S. equities experienced a broad selloff in June, with the S&P 500 index dropping 8.26%. All 11 S&P sectors suffered declines for the month. The traditionally defensive Consumer Staples sector declined the least, while Energy fell the most. The first half of 2022 was among the worst starts to a year in history for stocks – most major equity categories entered bear market territory, and the S&P 500 fell by 20% through June 30. 10-year U.S. Treasury bonds also experienced a wild swing over the course of the month, with yields jumping from 2.85% to 3.48% by mid-month, only to fall back to 3% by month end.1
U.S. GDP contracted at an annual rate of -1.6% in Q1 2022, and according to the July 1 GDPNow estimate from the Atlanta Federal Reserve, the economy may have contracted another -2.1% in Q2.2 The GDPNow forecasting tool is notoriously unreliable, but signs are pointing to two consecutive quarters of negative growth – the technical definition of a recession. Whether or not the U.S. entered recession in the first half of 2022 remains to be determined—the National Bureau of Economic Research (NBER) makes the official declaration, and in doing so they also weigh other factors like strength or weakness in the labor market, manufacturing activity, and real incomes.
If NBER declares that a recession began in the first half of this year, it would be different from the past 12 recessions the U.S. has experienced. In every postwar recession, economic output has fallen while the unemployment rate has moved higher. Over the past six months, however, the unemployment rate has fallen from 4% (December 2021) to 3.6% by the end of June. For context, there are 1.3 million Americans receiving unemployment benefits today, which is dramatically lower than the 6.5 million people on unemployment in the depths of the 2008 – 2009 Great Recession.3 Jobs remain plentiful, but the 4-week average of initial jobless claims has gone up for 11 of the past 12 weeks, and rising claims has historically been a leading indicator for economic weakness. This metric should be worth watching in the coming months.
The June Manufacturing and Services PMIs in the United States also are not yet flashing recessionary conditions. According to the Institute for Supply Management, the June Manufacturing PMI came in at 53%, which marked a significant deceleration from May’s 56.1% but still indicates expansion. A similar outcome was seen in the Services sector, which posted a reading of 55.3% and continues its streak of expansion for 25 months straight. Globally, flash PMIs show most major economies remain in expansion territory, though all have decelerated from the spring. Readings in the low 50s – where most major economies now reside – imply modest growth but not necessarily recession.4
Higher food and gas prices are clearly weighing on people’s attitudes about the economy, with the University of Michigan’s Consumer Sentiment Index falling to its lowest reading ever. Despite this, household finances remain relatively strong. At the end of Q1 2022, Federal Reserve data showed households with $18.5 trillion in cash in checking accounts, savings accounts, and money market funds. Before the pandemic, that figure was $13.3 trillion.5
Consumer spending rose by a seasonally adjusted 0.2% in May, marking the slowest increase in 2022, as sour sentiment is starting to affect spending habits. Retail sales fell in May for the first time this year, but a shift in spending from goods to services may have driven this decline. One bright spot was orders for long-lasting durable goods like refrigerators, cars, and washing machines, which rose 0.7% in May and marked the seventh increase in eight months. Orders for nondefense capital goods, which is a good indicator for business investment, also ticked 0.5% higher in May. 6
Commodity prices retreated in June largely across the board, perhaps as the market began to price in the likelihood that tighter global monetary policy would have the effect of cooling demand. Crude oil prices fell below $100 a barrel from $120 earlier in the month, and other raw materials like cotton, copper, lumber, wheat, corn, and soybeans all fell—in some cases dramatically—from highs. Commodity prices are notoriously volatile and can be affected by everything from the weather to geopolitics, but there is also the possibility that traders are anticipating more challenging economic conditions from here, which could curtail demand.7
The stock market’s weak performance in the first half of 2022 may signal that future economic weakness is already being factored into prices. But as we wrote in our June 13 piece titled “Battening Down the Hatches,” reduced earnings expectations may not be fully baked into prices just yet. Corporate profit margins are almost certain to retreat from record highs as producer prices remain elevated and labor costs rise. We think falling margins and growing uncertainty could cause companies to slow hiring and deliver more cautious earnings guidance for the rest of the year, which has equal potential to be a positive or negative surprise for the stock market. We therefore continue to believe it is appropriate to assume a more conservative stance in the portfolio, and continue to hold a higher-than-average cash balance along with a higher proportion of companies which we believe are less exposed to the potential headwinds of a recession.
As of June 30th, 2022