by Franklin J. Parker, CFA
The Summary
- Other than data on new home builds, this week is light on data. Investors, then, will be focused on earnings especially with big names reporting this week. Proctor & Gamble, Dow, Phillip Morris, American Airlines, Tesla, Freeport McMoRan, and many others, all report earnings this week, representing a significant portion of the S&P 500’s market capitalization. Last weeks’ earnings saw big name financials deliver pretty bad earnings, although much of that was expected. Investors are watching earnings very closely—inflation has begun to erode profit margins, and investors are looking for some clues for how long that will last.
- Last week producer prices—another look at inflation—posted at the highest level on record, a startling 11.2% over last year. This was on top of the 8.5% headline inflation rate. Though in-line with expectations, these figures are concerning because they seem to indicate that inflation is still accelerating. The Fed, of course, has just begun to tighten monetary conditions, so we cannot expect immediate reactions in the data, but it does create considerable doubt that they can slow inflation while not tipping the economy into recession (the so-called “soft landing” scenario).
- From a portfolio perspective, inflation represents a significant risk. Inflation is likely to erode corporate profits over the coming quarters, but it also makes cash a considerable risk. Balancing those two risks is a difficult task. For the moment, my view remains: I see the last half of the year delivering upside in markets, but it will likely be a rocky road to get there. As I have mentioned a couple of times now, I also see a recession likely developing in mid 2023, either as a result of inflation, the Fed, or both. Flexibility and caution are key themes for 2022-2023.
The Details
If one were to listen to the rhetoric, the whole project of globalization appears to reversing. Politicians have caught on that globalization has not been good for everyone, and there are blocs of voters who will support a reversal of open and free trade. Covid-induced supply chain struggles have also made a business case for the reshoring of supply chains.
Despite the headlines, so far the data appears to show the opposite. Total global trade, after taking a significant dip in 2020, has recovered strongly and begun to stretch to new highs, highs that are well above the last decade’s trend.
Generally speaking, strong international trade tends to follow global GDP growth, so all else equal this is a positive economic signal. The broader question is whether this recovery and new higher trend is sustainable in the current political and economic climate. Investors can keep an eye on this figure as a clue to the health of global economic growth, as well as how the whole globalization project is progressing (or not).
Chart of the Week
Everything about this economic cycle has been accelerated. The Covid-induced recession was over very quickly, and the subsequent market recovery has been among the fastest in recent memory. In that vein, many signals are beginning to indicate that another recession may be on the horizon (though not imminent). One of the earliest indicators we get of recessions is a closing of the GDP output gap, which is the difference between the theoretical output of the economy and the actual output of the economy. Though not yet closed, the GDP output gap has narrowed—indicating that the economy may be overheating and will need to correct.
This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from Directional Advisors to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own financial professionals, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.