The past two weeks have been epic for market-watchers and those that live and breathe financial news.  It started a couple weeks back with a Federal Reserve (Fed) rate hike of 75bps, then a much-anticipated gross domestic product (GDP) report, followed by the busiest week of earnings season which got most of the headlines.  And this was all before the past couple days which were riddled with inflationary data which added to the evidence that inflation has peaked.  There was even a surprise out of Washington D.C., with a Schumer-Manchin agreement on a climate-healthcare-tax bill.  What a start to August it has been.

Stocks expressed approval of this news, securing three straight solidly positive weeks and a breath of fresh air for investors. The S&P 500 Index enjoyed its best month since November 2020 and its best July in over 80 years. Last week’s gains were encouraging, and this week’s gains turned investors heads. Let’s look at each piece of news individually.

First, the Fed hinted at slowing the pace of interest rate hikes later this year then we receive the economic data everyone has been waiting for, reliable evidence in CPI and PPI that peak inflation has been seen.  Now, whether markets may have gotten a little ahead of themselves remains to be seen, but in the past six weeks, nearly 75bps has come out of the market’s expectation for the peak fed funds rate, which is the short-term rate controlled by the Fed to affect monetary policy. The inflation battle is far from over, but the market’s reaction has been encouraging, and the Fed may be poised to surprise the market with a pause by year-end.

Next, the first read on second quarter GDP revealed the U.S. economy contracted for the second straight quarter. The rule of thumb is two quarters of negative GDP defines a recession, but the official definition by the National Bureau of Economic Research is broader than that. With a strong, even if slowing job market and resilient consumer spending, we believe not enough sectors of the economy are contracting to qualify as an official recession. If a recession comes—probably a 50-50 proposition for the first half of 2023—it will likely be mild. A mild recession was probably already at least partially if not fully priced in at the June stock market lows, suggesting June 16 may mark the S&P 500’s ultimate low.

Capping off the busy week, the flurry of earnings reports demonstrated that corporate America has managed stiff headwinds effectively. Given the slowing economy, intense cost pressures, and a strong U.S. dollar clipping foreign-sourced profits, a 6% year-over-year increase in S&P 500 earnings per share during the second quarter is quite impressive. Estimates for the second half of 2022 and 2023 have come down as expected, but with expectations having gotten so low, stocks generally rallied on results even as estimate were cut.

Looking ahead, we are in August which has historically been a weaker month for stocks. We must also consider that midterm election year lows typically come around this time on the calendar for the S&P 500. These lows have historically been followed by an average gain of over 30% over the subsequent 12 months. Moreover, some of the timeliest leading indicators of inflation, such as commodity prices and various consumer and business surveys, indicate cooling to continue, even if it may be a slow process. Market-based interest rates—those not controlled by the Fed—have also come down quite a bit, which is supportive of stock valuations.

At the same time, geopolitical tensions are rising as House Speaker Nancy Pelosi visits Taiwan and the war in Ukraine continues. We watch these developments closely and look for trends or leading indicators that the landscape has changed, and I report to you our investors to provide what we believe to be the most prudent advice.  We believe the recipe of low valuations, lower interest rates, projections for inflation reducing, and the possibility that the Fed signals a pause over the upcoming months tip the scales toward the bulls. The ride probably won’t be smooth, but we believe long-term investors who sticks to their financial plan, and continue to invest with discipline, won’t have to wait too long to be rewarded for their patience.

Please contact me if you have any questions.  Stay safe, and stay the course.

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