Markets Take a Sigh of Relief as Inflation Cools

James Carey, Director, Investment and Portfolio Management Services

It’s been a strong summer for the markets, with the S&P 500 and especially the NASDAQ stock index rallying through July on news that inflationary pressures throughout the economy may be easing. Even the bond market, which experienced one of its worst first half returns on record, saw modest price gains, as expectations for future Federal Reserve rate hikes eased.

“Stocks have rallied in the past month after posting one of their worst first-half performances in decades, reflecting a popular bet on Wall Street that cooling inflation will permit the central bank to take a more supportive stance toward markets,” according to a recent The Wall Street Journal article.

The headline inflation reading for July was +8.5%, below expectations and a decline from the previous month’s +9.1%. While multiple signals, such as declining energy, commodity, and durable goods prices, are pointing toward a potential for continued easing of inflation from here, this outcome is far from certain.

“Investors are wrestling with whether the recent rally marks a lasting turnaround to stocks’ dismal first half of the year or whether it is destined to fade,” reports the Journal. “With inflation still a critical concern, the Fed is expected to keep raising interest rates, but investors are wondering how quickly and for how long. Traders have been caught in the crossfire between comments from Fed officials who project rates rising aggressively and market-based forecasts that expect the central bank to slow or reverse its rate hikes. … Higher interest rates reduce the value that many investors’ models assign to stock prices, so any hawkish sign from the Fed could pause the stock markets’ recent rally.”  

Factors Affecting Global Supply Chains

As Russia’s invasion of Ukraine continues, global energy and food supplies still remain constrained. Escalating geopolitical tensions between China, the United States and other allies are leading many businesses to consider de-globalizing parts of their supply chain, leading to potentially higher prices.

The U.S. and many other nations are experiencing acute labor shortages, as age demographics, early retirements, and an entrepreneurship boom are contributing to a smaller labor market and increasing competition for workers.

Finally, an uneven response globally to COVID-19, and the uncertain nature of the virus, leave global supply chains still delicate and precarious, even nearly 30 months into the pandemic. While inflation is easing for now, it’s clear that risks and headwinds remain on the path back to the Fed’s 2% target.

Big Jobs Report Puts Recession Talk Mostly on Hold for Now

The U.S. economy has now fully recovered all 22 million jobs lost early in the Covid-19 pandemic, after adding a higher than expected 528,000 jobs in July. The unemployment rate ticked down to 3.5%, tying the half century low last seen just before the pandemic began.

While the number of jobs is back to pre-pandemic levels, there are still 623,000 fewer people in the labor force, a factor contributing to strong wage growth and a very tight labor market. While second quarter U.S. GDP came in at -0.9%, the second consecutive decline after falling -1.6% in Q1, many economists are pointing to the historically low unemployment rate and continued strong hiring as signs that the U.S. economy is not likely to be currently in an official recession.

How the historically tight labor market drives rising wages and inflationary pressures from here, however, will be a carefully watched indicator.

What All This Means for Investors

We are encouraging investors to remain prudently cautious at this time, and to continue to expect ongoing volatility from here. While there has been a welcome reprieve in markets in recent weeks, numerous storm clouds remain, and the sharp reversal in investor sentiment over that short time has led some observers to suggest that the market has gotten ahead of itself with this recent rally.

It may be a good time for investment committees to evaluate if there is any cash needed in the near term from accounts, and to consider whether replenishing some cash reserves at current market levels may be advised.

Please feel free to reach out to us at 800-858-6127, Ext. 6 if we can help run this or any other analysis, or help answer any questions.

Market Updates at a Glance

The Dow Jones Industrial Average (DJIA) finished July at 32,845 up +6.73% for the month, down -9.61% year-to-date. The S&P 500 closed July at 4,130, up +9.11% for the month, down -13.34% so far for the year. The NASDAQ Composite gained +12.35% in July, down -20.80% for the year. Small-company stocks as measured by the Russell 2000, ended July up +10.38% for the month, down -16.04% year-to-date. Consumer Cyclical (+18.11%) and Technology (+13.33%) were the best performing sectors in July.