by Bryan Perry

July 12, 2022

Last week the market put up a good fight against what has been a protracted downtrend, posting some of the best gains of the year. Investors are trying to adopt the view that the Fed’s front-end loading of rate hikes, coupled with the recent selling in commodities, will have the economy skirting a recession.

Friday’s employment report helped this narrative in that the economy added 372,000 jobs, well above the forecast, with the unemployment rate holding steady at 3.6%, solidifying the view that the Fed will raise the Fed funds rate 75 basis points at the next Federal Open Market Committee meeting on July 27.

If history is any guide, the economy can avoid recession when labor markets are tight – such as now, when there are 11 million job openings and only five million people looking for work. Bond yields are ticking higher on this continued momentum in the labor markets, even as average hourly earnings were relatively flat month-over-month, implying inflation is still running well ahead of wage gains.

In light of a healthy job market, the Atlanta Fed lowered its GDP estimate on July 8 to -1.2% from -1.9%. Still, that would represent two consecutive negative quarters, which would qualify as a recession.

Atlanta Fed Gross Domestic Product Estimate Graph

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Other factors confounding investors are that very few companies have issued profit warnings heading into the second-quarter earnings season, which kicks off later this week, and yet many Wall Street economists are calling for an “earnings shock,” expecting widespread lowering of forward guidance. Certainly, the dollar trading at multi-year highs will pressure net income for companies with heavy overseas exposure.

The spread between 2-year and 10-year Treasury yields remains inverted, corroborating the Atlanta Fed’s forecast of meaningfully slower growth this year. Some of this assumption might be tied to rising levels of consumer credit reported for Q1’22, with Q2 data yet to be released. Households had strong savings coming into 2022, and strong travel plans, home and auto purchases, resulting in hot inflation in the past six months, which likely reduced this cushion. That would explain increased balances in revolving credit.

Consumer Credit Bar Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

If the recent decline in energy- and food-related commodities can be maintained, then forward inflation data will likely show signs of ebbing. Tomorrow and Thursday will bring us the release of June inflation data in the Consumer Price Index (CPI) and Producer Price Index (PPI), each of which will matter greatly to the narrative. What seems most evident is that the market remains cautious, evidenced by lower-than-average volume during this current six-day rally with the dollar remaining pegged near its highs.

It is important to note that with inflation running between 6% and 8.5%, depending on what number one chooses to work with, conventional fixed income provides cover from market volatility, but still comes well short of meeting yield to beat inflation. However, credit spreads have widened out, and some diligent screening will find that 5-year BBB+ corporate bond yields with 5% coupons can be found. BBB+ is the lowest level of investment grade bond category.There are some  5-year BBB+ credits for example;

  • General Electric 0% of 4/15/2027 trading at a discount of $986 per $1000 face has a 5.32% yield to maturity.
  • Goldman Sachs 0% of 7/6/2027 trading at a discount of $991 per $1000 face has a 5.20% yield to maturity.
  • Citigroup 0% of 6/30/2027 trading at a discount of $989 per $1000 face has a 5.28% yield to maturity.

I have no position in these bonds.

On February 10, when the Fed funds rate was near zero (0.0% 0.25%), the Committee for a Responsible Federal Budget (CRFB) calculated that, “if interest rates are 200 basis points (2.0 percentage points) higher, average annual interest costs would increase by $375 billion. Interest payments would total $9.2 trillion over the FY 2022 to 2031 period, and federal deficits would increase…by $418 billion per year.”There is always risk of yields moving higher, if inflation persists, but I believe the bond market has likely priced in two more rate hikes, and the Fed can’t let rates rise too much from current levels or the cost of servicing the Fed’s balance sheet and the federal debt will be in the upper hundreds of billions of dollars per year.

Interest Costs Bar Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

There isn’t much discussion about this elephant in the room because Modern Monetary Theory (MMT) is being advocated at the Federal Reserve, the U.S. Treasury, Congress, and the White House. It is totally experimental and, the last I heard, there are no plans to cut back on federal spending in future years.

While I’m as pleased as anyone to see the market putting together a decent rally since mid-June, it is vital to determine if we are looking at just another bear market rally or something more constructive and longer lasting. In a bear market, a bottom is determined when the S&P 500 SPDR ETF (SPY) puts in a “higher low” off the previous bottom and holds that level on rising volume.

The chart of the S&P 500 ETF (SPY) below, shows how this move up of late is contrasting a higher-low pattern, but on declining volume, as indicated underneath, making this rally suspect of being sustained. Understanding that this is a purely technical observation, it holds water in that 70% of the daily volume on NYSE and Nasdaq are driven by algorithms that heavily influence the world of ETFs and fund flows.

Standard and Poor's 500 Exchange Traded Fund (SPY) Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The market is defined as a forward discounting mechanism, meaning that it tries to price in the next six to nine months of expectations in today’s real time. If the narrative is that the U.S. economy and the global economy are expected to have bottomed by year-end, then the S&P and other major indexes should form true bottoms on expanding volume and begin an orderly recovery in the fourth quarter of 2022.

That outcome depends on historical market behavior repeating itself, and there is good reason to think that could happen if the Fed will slow the pace of interest rate hikes in September. Until then, opinions and views are all over the place, and investors just have to let each company of significance provide third-quarter guidance and see how inflation and other data come in, starting with this week’s inflation data.

Stay tuned for more July fireworks. They’ll be in full view on Wall Street.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

Also In This Issue

A Look Ahead by Louis Navellier
Core Inflation is Steadily Declining

Income Mail by Bryan Perry
A Heavy Week Ahead for Inflation Hawks and Doves

Growth Mail by Gary Alexander
Beware Economic Freedom without Political Freedom

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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