Outlook and Market Review - Second Quarter 2022

Estimates of Real GDP by the Bureau of Economic Analysis show a contraction in the first two quarters of 2022. Real GDP fell 1.6% in the first quarter and 0.6% in the second quarter. While two successive quarters of negative GDP growth is a definition of a recession, the National Bureau of Economic Research (NBER) considers a wider set of measures before making an official designation. While the economy shrank, employment remained strong with a surprising increase of 528,000 nonfarm payrolls in July following an average of 388,000 job gains per month over the prior four months. The economy had a 3.5% unemployment rate in August. The strong labor market data may prevent classification of the first half of 2022 as a recession. The NBER takes from four to 10 months to make an official recession designation.

Whether or not the economy was in a recession in the first half of 2022, the average American is feeling the pain of an economy in trouble. Inflation measured by the Consumer Price Index is 8.5% on a year over year basis, even after a flat inflation month in July. The 10-year Treasury note, which serves as a floor for many other lending rates, has a 52 week range of 1.26% to 3.5%. Rates will continue to rise until the Fed sees inflation closer to the target rate of 2% for the core PCE, which is not likely anytime soon. An additional 50 basis point increase in the fed fund rate is expected in September, bringing the fed fund rate to 3%. The housing and durable goods markets have already been hit hard by higher interest costs. While costs are rising, households saw real hourly compensation fall by 4.4% in the second quarter. The misery index, a combination of the inflation rate and unemployment rate (currently about 12), now rests well above the acceptable threshold of 5 to 7.

Households are seeing wealth contract as asset values are dropping due to high inflation, rising interest rates, and low sentiment. Business earnings in the second half are likely to be weaker due to rising labor costs, declining productivity, and weaker consumer spending. The housing market is technically in a recession with six straight months of declining sales. Both residential and business investment should be drags on growth going forward. The stock market tends to be a leading indicator of the overall economy. The market has priced lower expected earnings using higher discount rates. The S&P 500® fell 4.24% in August bringing the yield to date to -17.02%. The Dow Jones Industrial Average® lost 4.06% in August and has a yield to date of -13.29%. A true recession in the next four quarters is likely to be a 50-50 proposition.

Economic turmoil is not confined to the U.S. Both the World Bank and the International Monetary Fund lowered their global growth estimates. Russia recently cut its natural gas pipeline (Nord Stream) to Europe driving up energy prices, increasing inflation pressure, and lowering the values of European currencies to multidecade lows. The Russian retaliation to Western Sanctions is likely to be long lasting. Stock prices in most European countries are falling and recession probabilities are rising. To combat inflation, higher interest rates are on the horizon in Europe. At the same time, China’s zero-COVID shutdown policy in response to a wave of new cases has slowed growth and caused domestic unrest. In the past, China boosted growth with debt-finance infrastructure and real estate investments, which now make up about 30% of China’s GDP. A property crash is underway with declining loans, unoccupied property, and protests over mortgage payments. The Chinese government is trying to balance a battle with an economic recession and COVID, for which it has no heard immunity due to the lockdown policy. The value of the renminbi (yuan) relative to the dollar is falling fast.