Strategy and Positioning written by Steve Orr, Chief Investment Officer; and Essential Economics written by Mark Frears, Investment Advisor

As of market close June 10, 2022. Returns in percent.

 Strategy & Positioning 

 — Steve Orr 

Too much

June is on track to be the “too much” month. Too much noise, news and negative sentiment. Markets climb walls of worry, but not before they first ram headlong into them. The bricks in the wall, in no particular order, include Ukraine, the virus strain of the moment, recession, China, and mid-term elections. Of course, the cornerstone is inflation. 

Mark has the details below, but from our view the conventional wisdom on inflation is following in the Fed’s footsteps. In 2021, the Fed repeatedly pushed the narrative that inflation was “transitory.” Wall Street was not so sure. This year both the Fed and Wall Street believed, at least until last Friday, that inflation had “peaked” and was rolling over. We certainly waved the “inflation moderation” flag back in the winter. 

The numbers do not lie, however, and our process is number-driven. Certainly, some goods prices have rolled over. Services, autos and housing prices continue to increase. These sectors are keeping prices higher for longer and causing traders to reassess what happens to company earnings. Supply chains have improved, but that means lots of goods in inventory. Consumer sentiment is near a 40-year low because most folks have not seen price increases of this scale in their lifetimes. 

Inventories of gasoline and diesel are below five-year averages, and the summer driving season is upon us. Thanks to these supply limitations, high gas prices will continue. Fuel users have reacted to higher prices by changing behaviors. Two anecdotal points: a local drive-thru restaurant normally sees a falloff in business during May and June. Not this year, as their customers stayed home and opted for drive-thru. Spot trucking freight rates in the central U.S. are starting to moderate, suggesting that shippers are not as frantic to get goods delivered. Meanwhile, the pandemic shutdowns around the Shanghai ports continue to be on-again, off-again. The ports of Long Beach and Charleston South Carolina just set their second and third best months ever for unloading containers. Just as demand is slowing thanks to high prices, more supply hits our shores. Memorial Day sales? How about big sales for the Fourth of July? 

Action

The European Central Bank finally realized, that like the Fed, it too is behind the inflation wave. Miniscule quarter-point rate increases were pushed aside last week as futures markets prepared for — wait for it — half-point increases. Remember that the ECB’s deposit rate was as low as -0.75%. Yes, Virginia, you can deposit money in European banks and get back less. Not our kind of Santa Claus. The ECB has a longer route to get to neutral, i.e., where inflation and short-term interest rates match. 

The ECB also has been buying bonds to inject money into the banking system in a program similar to the Fed’s. A worrisome point is that this program has focused buying more on the southern countries’ bonds at the expense of northern members. Now that this program is coming to an end, Spain and Italy bonds are falling in price versus their Euro peers. This brings back decade-old concerns of Euro stability. Expect the dollar to resume its recent rally. 

Fed speakers and the ECB seem willing to risk a recession to tame inflation, and the Street is rightfully worried. Twenty years of the Fed intervening when the Negative Noise level (stock market drops) got high enough conditioned traders to wait for the “Fed Put” in the form of lower rates or bond buying. Not this time. This morning’s 3% drop in U.S. stock indices is an unwelcome, but understandable reaction. 

This week

Last week’s drop in the S&P 500 took us to the bottom of the trading range, extending back to December 2nd. A a retest of lows is always a good sign that the market correction is working its way through. Today’s action takes the index back into Bear territory and price levels of March 2021. Bespoke Research points out that last week’s up-and-down price pattern has happened 13 times since WWII. The following Monday (today) was almost always negative. In 11 of the 13 cases, the index was higher six months later. The driving season will be over in three months, mid-term elections over in five. In the meantime, this week will be bumpy because of Friday’s quarterly option expiration.