May 9, 2022

The global economy continues to slow due to war-related supply shocks and Covid shutdowns in China. While Europe’s and China’s states of decline may pull the global economy down, the U.S. economy, for now, remains strong, supported by a resilient consumer and a rebounding service sector.  The labor market remains robust with continued strong job gains and 50+ year lows in both initial and continuing claims.  Housing remains strong, but spiking mortgage rates along with rapidly rising home prices are a cause for concern.  We are paying close attention for signs that affordability is starting to impact housing demand.

Oil and commodity prices may be peaking which, along with easing supply chain stress, is fueling hopes for peak inflation.  However, inflation will likely remain elevated with pressure from rising wages and rents.  The Federal Reserve (“Fed”) is behind the curve and increasingly turning more hawkish, but continues to slow-play tightening.  Federal Reserve Chairman Jay Powell confirmed a 50 bp rate hike in May and the next couple of meetings and essentially took a 75 bp hike off the table.  The Fed also announced the start of the balance sheet drawdown in June.  The Fed has never engineered a soft landing for the economy when inflation has been this high and unemployment this low.

While recession risk is increasing, we still expect growth in the economy and corporate profits in 2022.  The probability of a recession in 2023 could be 50%.  Once again, first quarter earnings season delivered positive surprises and upward revisions.  While S&P 500 estimates for calendar years 2022 and 2023 edged slightly lower, consensus is still looking for approximately 10% earnings growth for each of those years.  Investor sentiment is very negative as we enter the challenging May to October period for the market, compounded by the Presidential Cycle.  We expect the market to remain volatile and on the defensive until geopolitical tensions ease and evidence emerges that inflation is moderating.  Rising profits this year have been offset by P/E multiple compression (S&P 500 next twelve months price to earnings have gone from 21.5x to 17.5x).

We continue to monitor for risks including: (1) geopolitical (further Russian escalation/China moves on Taiwan), (2) margin pressures that may lead to disappointing profits, and (3) supply shocks and/or aggressive Fed tightening that lead to recession.