Quick Recap
- The S&P 500 closed at 3,863.16, down 19.46% YTD but up 5.36% over the past month. The VIX fell 8% to 24.27.
- Inflation rose 9.1% in June, even more than expected, as consumer pressures intensified, largely due to gasoline prices at the pump.
- The stronger than expected 1.30% rise in US consumer prices in June, should result in another 75bp rate hike at the July FOMC meeting.
- With commodity prices falling and wage growth moderating in recent months, the outlook for inflation does not look as bleak as it did a month ago. Accordingly, I think speculation about a 100bp hike this month looks to be misplaced.
Details
Equity market weakness has been broad based, as last week 10 out of the 11 Sectors (GICS) closed in the red with only Consumer Staples posting a 0.11% gain. The macro data and news headlines continue to impact the market in both directions. My research suggests the big picture key issues remain intact — 1) Inflation rates elevated relative to history; 2) The Fed still in tightening mode to get inflation under control; 3) The US and global economy is slowing; and 4) Corporate profit expectations remain too high and will likely need to be lowered.
Based on this backdrop, I continue to advocate, spend less time fretting over the day-to-day volatility and keep the focus on where markets are going. Overall, I think we may be getting closer to maximum pessimism for growth. However, I do believe U.S. corporate earnings need to be revised downward, given the slowing global growth outlook. Assuming this happens, we may finally begin looking forward to a more constructive outlook for stocks.
Scotsman’s Outlook
- Will higher prices subdue demand? Temporarily, if we are looking primarily at oil. However, if we look at soft commodities, i.e., food, the UN World Food Index is barely off its highs. Factor in the heat wave which is engulfing Europe (even Scotland?!) and the Western part of the US, food shortages already developing in Sri Lanka/South America, what will happen in Holland when farmers are put out of business and I have not even mentioned the situation in Ukraine/Belarus. Between those two countries, about 25% of the world’s potash is exported. If Odessa falls to Putin, how long will potash remain at this price level? If I look at corn prices, it is trading back at pre-Ukraine levels, which makes no sense to me or other grains whose yields benefit from fertilizers, I would think prices will be higher in a few months.
- As far as oil is concerned, it remains the input for over 7,000 products. It makes no sense to me for the Saudis to significantly ramp up production and sell more oil so they make less money. Bottom line is I think commodities will rally back, especially soft commodities. Given my view, I think inflation remains high rather than returning to 2%-3% this year.
- Another topic on my mind is global supply chains. Will things get better? I am not yet convinced.. I think all the tea leaves are pointing toward China changing its trade policy to focus on its Belt Road Initiative partners and eventually the BRICs countries. In those relationships, Beijing has better control of both ends of the distribution chain. I had an example presented to me earlier this month in Europe where a Japanese company which manufactures in China, cannot get their machines out of the Shanghai port for export to Germany. This has been going on for months, with no resolution in sight. In China, fresh lockdowns took place last weekend in Shanghai and until the authorities decide to end the current Covid policy, the delays of trucks into and out of the port will continue. So far, there is little sign of that happening.
- As to the Ukraine / Russian war, we are no closer to a resolution than we were at the start of the conflict. Putin started this war because he wants his Western border to be moved to the 1997 NATO borders and I believe that NATO will not let that happen. An enormous chunk of Eastern Europe would be returned to Russian control, putting Putin’s Western border on East Germany’s Eastern border. Free and released Poland, the Czech Republic, Slovakia, the Baltics, Slovenia, etc. all would be gone. This is the reason the Ukrainians, Baltics, and Poles in particular will fight with everything they have, should conflict come to them. It appears to me that Putin is trying to re-establish control of Eastern Europe and as I have written previously. This means all the foodstuffs, and the dozens of metals which Ukraine supplies to markets will be in short supply for some time.
- In the equities markets, volatility remains present. Investor sentiment is negative, but given the macro backdrop surprisingly not overwhelmingly negative. There have been no single digit bullish sentiment readings in the research/surveys I read. The doom I hear has far more to do with the economy than the markets, an interesting lack of connection there. I heard the Secretary of Commerce say the other day it is almost as if we are talking ourselves into a recession.
- The IPO market appears to be dead and SPACs may be going the way of blind pools from the 1960s. The latter is potentially a good sign for the markets. The stocks which are down over 50% in one year, usually take years to recover, which is good for the long term, but probably not great for now. New leadership is needed for the market to move higher.
- Finally, I have seen the statistical work which posits that when stocks get crushed in the first half of the year, they rally back. My concern is if US stocks do not rally by the end of September/early October, we will end the year on the lows based on historic data. Part of my concern is due to interest rates moving higher. I believe we need a fresh look at how the US economy is going to operate going forward rather than making decisions based on backward looking economic data.
- We continue to position our portfolios with a more defensive bias as evidenced by our beta of less than 1.
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