August 2022 Review and Outlook
Executive summary:
- Fed willing to risk recession to tame inflation
- Inflation still hot, with CPI at 8.5%, below the peak in June of 9.1%
- Equity markets sold off to finish the month lower
- Yield curve remains inverted
- Dollar trades at multi-decade high
Index performance for August:
Equity markets rallied throughout July and early August on perceived peak inflation data, with the expectations it would lead to a pivot from the Fed’s current rate hiking cycle. From the June lows to mid-August, the S&P 500 returned over 17%, while the Nasdaq 100 Index returned over 21%. The summer rally ended on August 26th, with Federal Reserve Chairman Powell’s hawkish speech at the Jackson Hole Economic Symposium.
Chair Powell noted the Fed will continue to use restrictive policy “for some time” to tame inflation, returning it to their preferred 2% level. He also warned that pivoting from this strategy too early might lead to similar inflation levels that we saw four decades ago when inflation peaked above 14% in 1980. The Chair said, “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”
Powell also talked about recent economic data being mixed, but in his view, the “economy continues to show strong underlying momentum.” Low unemployment, growing corporate profits and rising wages are positive items, yet inflationary items, such as CPI and PPI, are unacceptably high, though oil prices have declined steadily for two months, helping consumers at the pump. GDP has also trended negatively for two consecutive quarters leading pundits to say we are in a recession, yet the National Bureau of Economic Research (NBER), the body that declares recessions in the United States, has not declared this to be one yet, as GDI (gross domestic income) growth for the same period is trending positively. The NBER takes both GDP and GDI into equal account before declaring a recession.
For the month, the Nasdaq 100 Index declined 5.2%, the Nasdaq Composite fell 4.6%, the S&P 500 lost 4.2%, the Dow slid 4.1%, while the Russell 2000 was the best performer, only shedding 2.2%.
Rate Hike Odds:
The table below shows the number of implied 25bp rate hikes anticipated by the market via fed fund futures pricing.
Currently, the market expects a 75bp rate increase at the September Fed meeting, up from an expected 50bp increase before the Jackson Hole meeting.
Sector performance total return for August:
S&P 500, one year:
Russell 2000, one year:
Nasdaq-100, one year:
Treasuries:
The yield on the benchmark U.S.10-year Treasury now sits at 3.12%, below the June peak of 3.49%. The 30-year yield moved back above 3% at the beginning of August and now sits at 3.22%. Yield on the shorter-term 2s recently touched 3.50% (following Powell’s comments at Jackson Hole), which is the highest they have been since 2007. The yield curve remains inverted, with two-year treasuries yielding more than 10-year maturities.
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity:
2-year Treasury yield, one year:
10-year Treasury yield, one year:
30-year Treasury yield, one year:
Earnings commentary:
Earnings season has nearly concluded, and corporate profits for the S&P 500 grew modestly in Q2’22. According to Bloomberg data, the average upside beat was 4.07% for the quarter, while sales increased by 2.61%. The earnings growth rate stood at +7.14%, while sales growth rose 13.73% (mostly led by Energy). Sectors that saw outsized growth included Energy (+302%) and Industrials (+31%), while Financials (-23%) and Communications (-13%) declined.
For Q3 and Q4, though earnings growth expectations fell to about 6% from 10% at the beginning of the quarter, the modest decline, coupled with better-than-expected Q2 results, was supportive of equities. The question for the market is whether margins will hold and allow for the earnings growth analysts expect, or could a recession mean actual earnings declines.
VIX
Volatility picked up at month’s end following Chair Powell’s Jackson Hole commentary. The CBOE Volatility Index (or VIX), also known as the fear gauge, sank early midmonth to below 20 on better-than-feared earnings and economic data before closing out August near the monthly highs at 26.
VIX, August:
VIX, two-year:
Economic commentary:
The U.S. Department of Labor’s August 5th Employment Situation Report for July reflected a strong labor market posting better than expected numbers on job creation (+528,000 new vs. +250,000 consensus) and hourly wages (+0.5% vs. +0.3% M/M and +5.2% vs +5.1% Y/Y). The unemployment rate ticked lower as well to 3.5% vs. June’s 3.6%, while the labor force participation rate declined to 62.1% from 62.2% M/M.
July’s headline CPI was flat M/M after rising 1.3% in June, supporting the peak inflation theme, which helped sustain the summer market rally (+0.0% M/M vs. consensus +0.2% and up 8.5% Y/Y, a decline from 9.1% in June). Food costs increased again (+1.1% M/M and is now up 9.4% vs. Y/Y). This is the seventh increase in a row of 0.9% or more. Energy decreased by 4.6% after rising 7.5% in June. Less food and energy, core CPI increased 0.3% M/M and +5.9% Y/Y, both better than consensus.
PPI decreased in July (-0.5% vs. following a downwardly revised +1.0% in June). On a Y/Y comparison, the index for final demand decreased to 9.8% vs. 11.3% in June. The index for final demand, less foods and energy, was up 7.6% vs. 8.2% in June. This is still unacceptably high but coincided with the decrease in headline CPI, lending credence to the June peak inflation theme.
July retail sales (which do not adjust for inflation) were flat M/M (consensus +0.1%) following a downwardly revised June (+0.8% vs. +1.0%). Ex-autos, retail sales increased 0.4%, beating the consensus of -0.1%.
U.S. Initial Jobless Claims remain low, indicating a tight labor market. For the week ending August 20th, new claims were 243,000 (consensus 252,000), above the three-month average of 235,000. Continuing jobless claims decreased slightly to 1.415 million.
The U.S. Department of Commerce released the second estimate for Q2’22 GDP showing the economy shrunk by 0.6%, better than the advance estimate of -0.9%. The GDP Chain Deflator (price index) was revised up to 8.9% from 8.7%.
Personal income increased 0.2% in July (below consensus +0.6%), while personal spending increased only 0.1% M/M (consensus of +0.5%), below June’s downwardly revised +1.0% (from 1.1%).
The PCE Price Index was up 6.3% Y/Y versus 6.8% in June, and the core PCE Price Index, which excludes food and energy, rose 4.6% vs. +4.8% in June. On a monthly basis, the PCE deflator declined 0.1%, while core increased 0.1%.
The Conference Board’s Consumer Confidence Index rose to 103.2 (consensus of 98) from a downwardly revised 95.3 in July, the first increase in the index in four months, likely due to lower gasoline prices.
CPI Inflation – MoM:
CPI Inflation – YoY:
Commodities:
Oil:
Oil prices declined 7.5% in August. WTI traded as high as $123.70 back in March, a 14-year high. YTD oil is up 21% but is off 26% since that March high.
According to AAA data, the average cost of a gallon of regular gas in the U.S. is $3.84, down $0.38 or 9% from last month. In June, gasoline topped $5.00 a gallon.
Crude Oil front month contract for August:
Gold:
Gold declined in August by nearly 3% and is down 16% from the March highs of $2050. For 2022, gold is down 6%.
Dollar:
Persistent levels of elevated inflation in a rising rate environment continue to accelerate the U.S. dollar rally. The world’s largest reserve currency made a new two-decade high above $109 in August. The U.S. Dollar Index is up nearly 3% for the month and has gained over 13% YTD.
Cryptocurrency:
Bitcoin was up nearly 3% in mid-August before selling off to close out down over 15% for the month. Since its November all-time highs, Bitcoin is down over 70%.
Looking ahead:
The peak inflation equity rally subsided at month’s end following Chair Powell’s hawkish Jackson Hole commentary on inflation, markets and unemployment. Luckily the data-dependent Fed will get another set of economic data ahead of its September 21st rate decision. Key releases to watch include the August jobs report (9/2), CPI (9/13), PPI (9/14) and retail sales (9.15).
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The Market Intelligence Desk Team
Nasdaq
Nasdaq’s Market Intelligence Desk (MID) is designed to provide critical touch-points for timely trading analysis and market information.