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Key Points for the Week

  • The S&P 500 soared last week after seven consecutive weekly declines.
  • The Federal Reserve’s minutes confirmed expectations for at least two more rate increases of 0.5%.
  • Core PCE inflation increased 0.3% for the third month in a row. While above the Fed’s target, inflation, by this measure, is slowing from its recent peak.

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Economic Update

Last week, major U.S. stock indices moved higher for the first time in 7 weeks. The Dow Jones Industrial Average gained 6.2 percent, the Standard & Poor’s 500 Index was up 6.6 percent, and the Nasdaq Composite rose 6.9 percent, reported Ben Levisohn of Barron’s.

The change in investor attitude may have been influenced by a variety of factors, including:

  • Strong corporate earnings (profits). Not only were U.S. companies profitable during the first three months of this year, company leaders and market analysts anticipate they will remain profitable throughout 2022. Ninety-seven percent of the companies in the S&P 500 have reported earnings so far, and the blended earnings growth rate is 9.2 percent. Over the full year, analysts anticipate profits will increase by 10.1 percent, reported John Butters of FactSet.
  • More attractive share prices. The price-to-earnings (PE) ratio is one way for investors to understand whether a company’s stock is priced fairly. The PE ratio compares a company’s share price to its earnings (profits). At the end of last week, the forward PE ratio for companies in the S&P 500 Index was 17.1. That’s between the five-year average of 18.6 and the 10-year average of 16.9, reported FactSet.
  • Optimism about the Fed’s approach to tightening. The minutes for the Federal Reserve Open Market Committee meeting became available last week. Investors were encouraged by the Fed’s policy approach.

The rally…extended on Wednesday when the Federal Reserve, while acknowledging that it will lift interest rates further in the next couple of meetings, implied that it may slow down the pace of rate hikes if the economy continues to slow down

Jack Denton and Jacob Sonenshine, Barron’s

  • The possibility that inflation may have peaked. The rally continued after the Personal Consumption Expenditure Price Index, which is the Federal Reserve’s favorite inflation measure, showed the pace of inflation slowed in April. Headline inflation was 6.3 percent year-over-year, down from 6.6 percent in March.

While last week’s U.S. stock market rally was appreciated, markets are likely to remain volatile for some time.

This Week in the Markets

The S&P 500 ended its string of seven negative weeks by rallying 6.6% last week. The surge in stock prices gave the index some margin between its current price and the 20% decline the index flirted with just two weeks ago.

The Federal Reserve’s minutes from its last meeting confirm the Fed expects to raise rates 0.5% the next two meetings and then evaluate how inflation has changed. The minutes didn’t provide any surprises and reassured investors that they are reading the Fed’s intentions well.

PCE (personal consumption expenditures) inflation data provided markets a boost by indicating the slowing inflation trend in the Consumer Price Index was confirmed in the PCE data as well. Core PCE inflation, which excludes food and energy, increased 0.3% for the third consecutive month, and the yearly gain dipped below 5%. Inflation, including food and energy, was even lower because fuel prices fell in April. Next month, we expect inflation to jump because of higher fuel prices. We will watch core inflation to see if the trend toward slower inflation continues.

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Broader economic conditions remain strong. Durable goods orders climbed 0.4% and business investment rose 0.3% last month. Companies are likely ramping up investments in machines and other labor-saving devices to mitigate tight labor markets and high wage growth.

Global stocks rallied with the S&P 500. The MSCI ACWI leapt 5% The Bloomberg U.S. Aggregate Bond Index gained 0.8%. The U.S. employment situation leads the list of key economic reports this week. We’ll be paying attention to the overall job gains and how quickly wages are climbing.

Rally Caps

What causes markets to reverse direction so rapidly after seven weeks of decline? The S&P 500 rose 6.6% higher last week after barely avoiding the classic definition of a bear market the week before. Our comment last week that “…value is improving, and the seeds of the next market rally may have already been planted,” looks pretty good in retrospect, but we certainly didn’t forecast a 6.6% rally.

Last week’s rally was likely caused by a number of factors aligning to send markets higher. Let’s review:

  • Investment managers love to talk about having “dry powder,” which can be deployed if a market decline creates an opportunity to buy something cheap. What they don’t mention as often is they sometimes wait for signs the selling pressure is abating before jumping in. When selling slows and buyers sense an opportunity, markets can move quickly. After seven weekly declines, some investors had likely found stocks attractive.
  • The Federal Reserve continued to make its intentions clear to the market. The minutes from the most recent meeting earlier this month showed nearly full agreement on the plan to increase interest rates by 0.5% in each of the next two meetings in June and July. This would put the federal funds rate between 1.75% and 2%, which is a large increase from where it started the year, at 0.25%, but not as high as some feared. After the two additional 0.5% hikes, some Fed members prefer to reassess if more hikes are needed, while others want to keep raising rates.
  • Core inflation, which excludes the volatile effect of food and energy prices, came in at 4.9%. This is still a lot higher than the Fed’s target of 2% but is a decline from the previous month, which showed a 5.4% increase. The threat of higher rates and other factors have already started to slow inflation.
  • Economic data released last week showed a recession may be further off than some feared. New orders for durable goods (products with at least three years of life expectancy) have remained strong, rising 0.4% month-over-month following March’s 0.6% increase. Six of the last seven months have been positive. As a leading economic indicator, durable goods continue to signal that the U.S. economy remains healthy. Additionally, new orders for nondefense capital goods ex-aircraft, which is a proxy for business investments, continue to rise, coming in with 0.3% month-over-month and 7.5% year-over-year gains.
  • S&P 500 companies are investing in technology to help combat the ongoing labor shortage. Capital expenditures are currently 23% above pre-pandemic levels — indicating companies see higher demand continuing. After dropping sharply in the initial stages of COVID-19, capital expenditures surpassed the previous high in 1.5 years and have now surged past previous levels. In 2008, it took nearly twice as long to for capital expenditures to recover.

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None of these factors were overwhelming, but the combination of better economic data and a kinder-than-expected Fed contributed to the gains.

Will markets finally calm down? Our expectation is they will not. The risks of stubborn inflation, an overaggressive Fed, and a possible recession all declined last week, but they didn’t go away. Also, markets are usually volatile in an election year.

There has been a 1% move every week this year, and big moves to the upside can reverse quickly. Upside volatility still counts as volatility and suggests investors can switch their sentiments quickly. The daily swings in the last weeks also suggest the market remains volatile. The last six weeks have experienced some of the biggest daily moves. This market is likely capped in how far it can run until better inflation data signal the macro risks are decreasing. Then volatility may start going down.

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Tax Return Processing Status Update

As of May 14, 2022, the IRS had 9.8 million unprocessed individual returns, including a backlog of 7.4 million paper returns waiting to be processed, and 2.4 million unprocessed individual returns that required special handling. There are also millions of unprocessed amended tax returns, which the IRS has indicated will take longer than the normal 16 weeks to be processed. Lastly, there are just under 300,000 amended employer quarterly federal tax returns that have not been processed. The IRS has not provided an estimated timeframe for when these returns will be processed.

Did you Know? This Week in History

June 2, 1935: Babe Ruth Retires

On June 2, 1935, Babe Ruth, one of the greatest players in the history of baseball, retired after 22 seasons, 10 World Series and 714 home runs. The following year, Ruth then became one of the first five players to be inducted into the baseball hall of fame.

Ruth’s rise to stardom began when he made his Major League debut as a left-handed pitcher with the Red Sox in July 1914. He pitched 89 winning games for the team before 1920, when he was traded to the New York Yankees. After Ruth left Boston, in what became known as “the curse of the Bambino,” the Red Sox didn’t win another World Series until 2004. In New York, Ruth’s primary position changed from pitcher to outfielder. Ruth was a huge star in New York and attracted so many fans that the team was able to open a new stadium in 1923, Yankee Stadium, dubbed “The House That Ruth Built,” after having led the Yankees to seven American League pennants and four World Series victories.

Many of the records Ruth set remained in place for decades. His career homerun record stood until 1974, when it was broken by Hank Aaron. Ruth’s record of 60 homeruns in a single season (1927) of 154 games wasn’t bested until 1961, when Roger Maris knocked out 61 homers in an extended season of 162 games. Ruth’s career slugging percentage of .690 remains the highest in Major League history.

Ruth died of throat cancer at age 53 on August 16, 1948, in New York City. His body lay in state at Yankee Stadium for two days and was visited by over 100,000 fans.

Weekly Focus

It's not about what it is, it's about what it can become.

Dr. Seuss, Author and Poet

It takes time to create excellence. If it could be done quickly, more people would do it.

John Wooden, Basketball Coach and Player