|Close||Weekly return||YTD return|
|US Treasury 10yr Yield||2.654%||-10.0%||75.59%|
Source: Wall St. Journal
This week was action-packed, with more than 170 companies reporting earnings, in addition to a slew of economic data. We can safely assume at this point those corporate earnings, while still relatively strong overall, are slowing. Amazon posted a loss for a second straight quarter. Microsoft reported its slowest earnings growth in two years. So why was the market so strong this week? Simply put, investors feared worse. And there you have it. Earnings are what they are. It’s what investors feel about those earnings that drives stock prices in the short term. The market had become quite pessimistic coming into earnings. It appears they were too pessimistic. Nonetheless, the headwinds facing the US economy are still here. Second quarter GDP contracted. That is two quarters in a row of negative GDP growth (economists blame it on business inventories – businesses bought too much inventory previously so there wasn’t the typical inventory “build” in the second quarter – see chart of GDP components). That has been the definition of a recession used by many for decades. Yet, the other factors that really define a recession aren’t there. Rising unemployment. Nope. A broad-based decline in spending. Nada (see chart on purchases for big ticket goods). The global economic shutdown in 2020 is still reverberating around the world. Getting back to “normal” hasn’t happened…yet. It will. It will just take time.
Despite the Federal Reserve hiking rates another 75 basis points on Wednesday, monetary policy is still accommodative. Inflation is far higher than the Fed funds rate. Real yields are still negative. That is not restrictive. Traders are now more comfortable that the Fed will stop raising rates by early next year and could start cutting rates again. Why do they think this? Slowing earnings! These interest rate hikes are having the effect the Fed wants. A slowing economy should lower inflation. Why? Lower demand and or supply of goods means fewer dollars chasing fewer goods, vs what we’ve been seeing – too many dollars chasing too few goods. That’s what all the fuss is about rising interest rates. The $64,000 question is, “are they right?”. With a tight labor market and decent wage gains, it will be difficult to rein in inflation quickly. We could be looking at elevated inflation for a while because almost everything is pushing prices up. Rents are rising just as gasoline prices are declining. Rents are a much larger % of the inflation basket, so the effects of falling gasoline prices may not be enough to bring inflation back to the 2 to 2.5% range. Everyone seems to be surprised by almost every economic reading lately, so ruling out a material decline in inflation rates may not be as farfetched as it seems. It would be welcomed but the odds of it happening quickly are low.
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