At a glance
Stocks had a strong July, despite a slowing U.S. economy. Higher short-term interest rates from the Federal Reserve and lower long-term interest rates present a challenging backdrop.
U.S. Bank Global Health Check
The U.S. Bank proprietary Global Health Check incorporates more than 1,000 data points — including business climate factors and economic sector categories for 22 major economies representing 80 percent of total global wealth — to reflect our view of the current strength of worldwide economic growth.
Number of the week:
The annualized U.S. real gross domestic product in the second quarter. It’s the second consecutive quarter of negative growth, following -1.6% last quarter.
Term of the week:
Contraction – In economics, contraction refers to a phase of the business cycle in which the economy as a whole is in decline. A contraction generally occurs after the business cycle peaks, but before it becomes a trough. According to most economists, when a country's real gross domestic product has declined for two or more consecutive quarters, a recession has occurred.
Quote of the week:
“To be determined is whether the July performance is indicative of a market bottom. Elevated inflation, slowing economic growth and rising interest rates suggest that the strong performance in July is a bear market rally, rather than a market bottom. Conversely, earnings are holding up reasonably well, providing valuation support.”
― Terry Sandven, Portfolio Manager, Chief Equity Strategist, U.S. Bank
- The U.S. economy shrank for the second quarter in a row, to an annualized rate of -0.9% for the second quarter. A 2% drop in inventories was the primary driver; exports recovered and spending on services remained strong. Two measures of consumer sentiment, from the Conference Board and the University of Michigan, remain at very low levels, though consumer spending remains solid, due in part to robust wage growth. The Employment Cost Index rose 5.1% year-over-year through the second quarter, with wages rising 5.2%. However, the Fed’s preferred inflation measure, the core Personal Consumption Expenditure deflator (excludes food and energy), accelerated to 4.8% over the past year, absorbing most of the wage increases. A solid July employment report this week may affirm that consumer health remains solid, despite recent economic weakness.
- The Eurozone economy performed well over the past year, expanding 4% through the second quarter, slower than the 5.4% pace in the first quarter but much faster than consensus forecasts. Inflation, with consumer prices rising 8.9% for the year ending in July, and waning consumer and business sentiment in the face of energy risks from the Russia/Ukraine conflict are weighing on forward prospects.
- China appears to be struggling to recover from regional coronavirus lockdowns. The official July survey of manufacturing purchasing managers moved back into contraction. Reports from non-manufacturing managers indicated slower activity, though still expanding. Releases from this week’s Politburo meeting indicated China is unlikely to reach growth targets set early this year and is unlikely to use new stimulus measures to lift output.
- The stock market had a strong July. The S&P 500 advanced 9.1% and all 11 sectors posted gains for the month. The Consumer Discretionary (18.9%) and Information Technology (13.5%) sectors led for the month. For the year, performance remains lackluster. The S&P 500 ended July down 13.3% in 2022, with nine of 11 S&P 500 sectors in negative territory.
- To be determined is whether the July performance is indicative of a market bottom. Elevated inflation, slowing economic growth and rising interest rates suggest that the strong performance in July is a bear market rally, rather than a market bottom. Conversely, earnings are holding up reasonably well, providing valuation support.
- Second quarter results present mixed signals, though guidance is largely positive. Sales and earnings are trending up 13.8% and 6.0%, respectively, with 56% of S&P 500 companies reporting as of Friday’s close. Expectations heading into the quarter were for sales to increase 10.3% and earnings to rise 4.5%. However, Energy and Industrial sector earnings are the primary contributors. Five of 11 S&P 500 sectors are posting negative year-over-year earnings growth, adversely impacted by macroeconomic headwinds. Consensus for 2022 and 2023 earnings projections are trending modestly lower, roughly $226 and $244, respectively, but still above beginning-of-year levels.
- Businesses continue to spend on technology and targeted ads, bolstering sentiment and Consumer Discretionary and Information Technology performance in July. E-commerce sales remain soft, with consumers yearning to get out and into stores, restaurants, destinations and “experiences.”
- The Fed increased its target federal funds interest rate by 0.75% to a range of 2.25% to 2.50% last week. Chairman Jerome Powell said the policy rate is near neutral (neither restrictive nor stimulative) and another 0.75% increase at the September meeting is possible. Investors now expect the policy rate to near 3.3% by year end before falling by the end of 2023. Powell said the June Summary of Economic Projections, which details Fed projections for economic data and interest rates, is still the best reflection of the Fed’s thinking. That shows rate hikes to 3.0% to 3.5% by year end and more next year. Tighter monetary conditions paired with slowing growth are key factors influencing our somewhat defensive positioning in diversified investment portfolios.
- Riskier high yield corporate and municipal bonds performed well last week. Second quarter earnings have proven resilient so far. On balance, company cash levels are still high, though declining. We favor investment-grade corporate and municipal bonds, since these issuers have stronger balance sheets that help provide a buffer against near-term economic challenges.
- Real Estate outperformed the S&P 500 by 1% last week as interest rates fell. Residential and office properties were the top performers, while data centers and retail lagged. Valuation multiples have recovered some recently with the decline in interest rates, which is a positive for real estate prices.
- Infrastructure outperformed the S&P 500 last week, led by midstream energy and utilities, which beat the index by 4% and 2%, respectively. Airports were the main detractor from performance.
- Crude oil rose 4% last week, with domestic inventories of crude and refined products falling. We still see the crude market as undersupplied, which should be supportive for prices over a longer time horizon.
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