CPI may rise, but not because there is a true inflation process—rather, because some of the prices of goods in the CPI basket have gone up. The average of all prices will rise if some prices increase by a lot, even if most prices do not rise and some even fall a bit. If incomes do not rise to match, these relative price changes are actually deflationary.
- Carl Weinberg
With Federal Reserve Chairman, Jerome Powell, attempting to tame inflation with the only tool at his disposal: interest rates. FOMC meetings have turned into a game of Russian Roulette as each rate hike causes financial markets to test new lows. What started with inflation being transitory, has prompted the Fed to back-peddle, flipping the script on the definition of transitory, causing fear-induced fund outflows. In this month’s issue of The Samra Report we examine the probability of a recession and make the case for economic expansion.
The world of finance is like the world of medicine, in that there are an infinite number of variables. However, in addition to these variables are parties, typically investment firms, with a vested interest for providing bias research and guidance. This explains the confusion of digesting research from Wall St analysts, and the dispersion of equity opinions amongst investments firms. Marco Kolanovic of J. P. Morgan has an S&P 500 price target of 4,900 for 2022, Mike Wilson with Morgan Stanley forecasts a 4,400, Goldman Sachs 4,700 and Bank of America’s Savita Subramanian forecasts 4,500, a far cry from the current sub 3,800 level. At Samra Wealth Management we believe the market is oversold, and although the Federal Reserve is laser-focused on reducing inflation by reducing demand, we believe the U.S. economy to be resilient.
As we enter Bear market territory, the financial media shows blatant disregard for data, causing panic amongst investors with talks of recession, “as the correlation between stock returns and economic growth across countries can be negative.” The definition of a recession according to the National Bureau of Economic Research (NBER), which officially declares recessions, defines a recession as: “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” At Samra Wealth Management we believe the US economy is likely to experience a decline in GDP, however, the duration of which would be short-lived and probability of a recession low. With 2021 U.S. GDP growth of 5.7% and an S&P 500 gain of 26.89%, the Feds monetary policy stance should be viewed as a speedbump, as opposed to an attempt to derail the economy or financial markets.
According to Factset, “although analysts were decreasing EPS estimates in aggregate for the second quarter, they were also increasing EPS estimates in aggregate for the next two quarters by small margins,” suggesting a return to trend in the S&P 500 by year-end. In addition, factset provides supporting evidence for an oversold market with the following statements, backing Benjamin Graham’s belief that investors are irrational.
S&P 500 companies that have reported negative EPS surprises have seen a much larger negative price reaction than average reported by S&P 500 companies for a quarter since Q2 2011 (-8.0%).
The largest average negative price reaction to positive EPS surprises reported by S&P 500 companies for a quarter since Q2 2011 (-2.1%).
Of the 491 companies in the S&P 500 that have reported earnings to date for 22Q1, 77.6% have reported earnings above analyst estimates, according to Refinitiv. This compares to a long-term average of 66% and prior four quarter average of 83.1%. Should a recession be eminent, we would expect to see a deviation in key indicators. The Federal Reserve Bank of Philadelphia produces a monthly coincident index for each of the 50 states:
The coincident indexes combine four state-level indicators to summarize current economic conditions in a single statistic. The four state-level variables in each coincident index are nonfarm payroll employment, average hours worked in manufacturing by production workers, the unemployment rate, and wage and salary disbursements deflated by the consumer price index (U.S. city average). The trend for each state’s index is set to the trend of its gross domestic product (GDP), so long-term growth in the state’s index matches long-term growth in its GDP. The Federal Reserve Bank of Philadelphia has released the coincident indexes for the 50 states for April 2022. Over the past three months, the indexes increased in all 50 states, for a one-month diffusion index of 100. For compassion purposes, the Philadelphia Fed has also developed a similar coincident index for the entire United States. The Philadelphia Fed’s U.S. index increased 1.1 percent over the past three months and 0.3 percent in April, shown below. The image suggests; if a recession was eminent, we would expect to see economic slowdown in some states.
According to Merrill Lynch: “Macroeconomic stress could cause the Fed to slow rate hikes.” However, we believe a deviation from the Feds plan would show a lack of confidence and could send markets into turmoil. Alternatively, we expect corporations to streamline operations; implementing cost-cutting measures including layoffs, followed-up by a significant increase in stock buybacks. As interest rates continue to rise, we further expect dividend-paying stocks to increase dividend ratios to compete against the “risk-free” return of owning treasuries, potentially setting up U.S. markets for a return to 2021 highs.
In the short-term the idea of an economic expansion or return to financial market highs may appear improbable due to supply-chain issues, labor-shortages, and energy inflation. At Samra Wealth Management we believe these issues are transitory: We expect supply-chain issues to alleviate by the fourth quarter for most industries and expect an increase in retail sales due to increased inventories. We further expect labor-shortages to decrease from an increased labor force participation rate, stemming from wage increases to attract talent.
Although we believe the volatility will continue until Q4, our sector rotational strategy remains intact, weighted highest towards technology, healthcare, financials, industrials and select e-commerce companies. We expect to reduce our tactical allocation towards energy, increasing allocations towards real estate, high yield fixed-income, and private equity.
Finally, at Samra Wealth Management we strongly believe most of the burden will weigh heaviest on those on the lower end of the income spectrum. Although we’ve previously written about low interest rates serving as a tax on the wealthy, returning risk-free returns lower than inflation. Increased interest rates serve as a tax on the poor, and we expect to see many first-time homebuyers priced out of the market.
This material is provided as a courtesy and for educational purposes only. This does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.
All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed. All economic and performance data is historical and not indicative of future results.
Nasdaq is a global electronic marketplace for buying and selling securities. Originally an acronym for "National Association of Securities Dealers Automated Quotations"—it was a subsidiary of the National Association of Securities Dealers (NASD), now known as the Financial Industry Regulatory Authority (FINRA). Indexes are unmanaged and do not incur management fees, costs or expenses. It is not possible to invest directly in an index.
The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. Indexes are unmanaged and do not incur management fees, costs, or expenses. It is not possible to invest directly in an index.
All views/opinions expressed herein are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC.
Investing involves risk including loss of principal. Investment advisory services offered through Samra Wealth Management, a Member of Advisory Services Network, LLC.
Adinolfi, J., 2022. Why a top Wall Street quant sees S&P 500 taking back all its losses by year's end. [online] MarketWatch. Available at: <https://www.marketwatch.com/story/why-a-top-wall-street-quant-sees-s-p-500-taking-back-all-its-losses-by-yearend-11654117457> [Accessed 14 June 2022].
Alliancebernstein.com. 2022. Global Macro Outlook - Second Quarter 2022. [online] Available at: <https://www.alliancebernstein.com/gb/en-gb/adviser/insights/economic-perspectives/global-macro-outlook-second-quarter-2022.html> [Accessed 14 June 2022].
Butters, J., 2022. EARNINGS INSIGHT. [online] Advantage.factset.com. Available at: <https://advantage.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_061022A.pdf> [Accessed 14 June 2022].
Dhillon, T. and Alonso, T., 2022. This Week in Earnings 22Q1 | May 20, 2022 | Lipper Alpha Insight | Refintiv. [online] Lipper Alpha Insight. Available at: <https://lipperalpha.refinitiv.com/2022/05/this-week-in-earnings-22q1-may-20-2022/> [Accessed 15 June 2022].
Insight.factset.com. 2022. Analysts Lowering EPS Estimates for Q2 2022 but Not Lowering EPS Estimates for 2H 2022. [online] Available at: <https://insight.factset.com/analysts-lowering-eps-estimates-for-q2-2022-but-not-lowering-eps-estimates-for-2h-2022> [Accessed 14 June 2022].
Lipperusfundflows.com. 2022. US Fund Flows Data Services. [online] Available at: <https://www.lipperusfundflows.com/#create:home:Home:/php/signup_trial.php> [Accessed 14 June 2022].
Msci.com. 2010. Is There a Link Between GDP Growth and Equity Returns?. [online] Available at: <https://www.msci.com/documents/10199/a134c5d5-dca0-420d-875d-06adb948f578> [Accessed 13 June 2022].
Philadelphiafed.org. 2022. State Coincident Indexes. [online] Available at: <https://www.philadelphiafed.org/-/media/frbp/assets/surveys-and-data/coincident/2022/coincidentindexes0422.pdf> [Accessed 14 June 2022].
Philadelphiafed.org. 2022. State Coincident Indexes. [online] Available at: <https://www.philadelphiafed.org/surveys-and-data/regional-economic-analysis/state-coincident-indexes> [Accessed 14 June 2022].
Weinberg, C., 2022. The worst of "inflation" is behind us - High Frequency Economics. [online] High Frequency Economics. Available at: <https://www.hifreqecon.com/the-worst-of-inflation-is-behind-us/> [Accessed 14 June 2022].
Zara, C., 2022. Crypto layoffs loom as tokens crash: Coinbase, Crypto.com, and others cut staff. [online] Fast Company. Available at: <https://www.fastcompany.com/90760988/crypto-layoffs-loom-as-tokens-crash-coinbase-crypto-com-and-others-cut-staff> [Accessed 14 June 2022].