by Franklin J. Parker, CFA
The Summary
- Earnings season is offering investors a much-needed view on both the current economy and the expected future economy. Two-thirds of S&P 500 companies have reported earnings (including big banks and big tech), and we are seeing earnings growth in excess of what was expected. As it stands, quarterly earnings are about 6% higher today than they were last year, and revenue growth is posting at around 12%. While this is much lower than the double-digit profit growth of the past few quarters, forward guidance has given investors some hope: both Q3 and Q4 are now expected to post around 7% profit growth.
- Last week’s Fed decision pushed rates 0.75% higher. Investors latched on to Powell’s comments suggesting a slowing of further rate hikes, or possibly a pause to give time for the current moves to have their effect in the economy. Of course, the very next day we got GDP data showing that the US economy contracted for the second quarter in a row. While this is the usual, shorthand definition of a recession, investors will have to wait months to hear whether the NBER officially declares it as one (and by then the world will have moved on). This week we see data on jobs, manufacturing, and consumer credit—all of which is important.
- As I have said repeatedly, if we are in a recession it is a very strange one. Corporate profit growth alone is enough to give investors pause before allocating in a purely defensive manner. That is not to say that I expect smooth sailing, far from it, in fact. However, this environment does give nimble and thoughtful investors a chance to shine. As always, your goals and view of markets will dictate what risks you can and cannot afford to take.
That is a conversation you should not be having alone.
The Details
There is a bit of a mystery developing in the US economy.
Relative to inflation, consumers have seen their wages fall over the past year. Despite this drop in income, consumers have more-or-less maintained their purchasing power. Now, enter the mystery: the amount of consumer credit outstanding has been falling over the past months. So where are people getting the money?
The answer is likely personal savings. Since the pandemic high, personal savings has dropped to a multi-year low, and appears to be continuing to fall. Since consumer credit has also fallen dramatically, we might conclude that households are tightening up their balance sheets—possibly in anticipation of some difficult times.
Of course, households will not spend down their savings forever. Once that limit is reached, consumer spending will have to be drawn from credit, or curtailed altogether. Investors would do well to keep a close eye on these figures over the coming months.
Chart of the Week
I’ve read many an article about how the Fed’s rate hikes are likely to cause a recession. While I do not necessarily disagree, the last 30+ years of history has shown us is that the Fed is actually pretty good at recognizing when a recession is on the horizon, and cutting rates to get ahead of it. In fact, the Fed has not once—in the last 30 years of history—increased rates immediately ahead of a recession. There are always exceptions, of course, and this unusual environment may well be one, but investors have some reasonable basis to follow the Fed’s actions on this.
At the moment, the Fed’s behavior suggests a recession is not immediate.
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