Anthropologist Franz Boas was traveling through Baffin Island in northern Canada during the 1880s and wanted to study the life of the local Inuit people. What Boas found was a language that can ascribe a deeper meaning and nuance in forming a single word. For example: qanuk: ‘snowflake’, kanevvluk: ‘fine snow’, qanisqineq: ‘fallen snow floating on water’. There is even a word for ‘snow that is good for driving the sled’, piegnartoq. Initially dismissed as exaggeration, it turns out Boas was right about the great variety of words in Aleut and Yupik languages that can be used to describe snow and ice.
Whatever we call this current economic period in hindsight, it is becoming clear that growth rates will slow in response to future Fed tightening. Inflation that started out last year as a few snowflakes has turned into more of a blizzard. Some Fed officials are talking about 50 or 75 basis point moves in the Fed funds rate to melt inflation a bit faster. That has thrown cold water on the stock market rally of the last few years, which has generated average returns of about 20% per year in the S&P500.
Q1 GDP was reported Thursday at -1.4%. Not positive on the surface, but this is a “real” GDP number, meaning inflation is subtracted out. Nominal GDP grew by 6.5% in the quarter, but since the price index was up 7.8% that creates the negative GDP reading after inflation. There were some other anomalies in the GDP report as the Omicron variant of Covid spiked in Q1 while several government assistance programs tapered off. Personal consumption expenditures actually rose by 2.7% in the first three months of the year. However, inventories were burned up to meet demand and imports rose faster than exports, both negatives to the calculation. So again, a very mixed picture with decent underlying consumer strength but offset by high inflation.
Markets look ahead though, and are already pricing in higher interest rates and a slower economy. Some economists put the chance of recession at close to 35% going into next year. Others suggest that the Fed can engineer a soft landing. The stock market (S&P500) returned -4.6% in the first quarter and is down close to 10% YTD, while large-cap growth stocks have declined about 16% and value-oriented stocks have declined about 4% YTD. Bonds had their worst first quarter since 1994, worse on the long end than the short end of maturities. After strong earnings growth last year resulting from a Covid pandemic rebound, earnings comparisons in the first half of this year are much more difficult. Last year S&P 500 earnings grew by 27%. Corporate earnings are pegged to grow about 9% this year and 10% next year, which could get scaled back as the Fed does its work to reduce inflation and, consequently, slows economic growth.
For now, markets are looking through the GDP report and rallied 2-3% yesterday after a large dip earlier in the week. So far, about 75% of S&P500 companies reporting have beaten earnings expectations. While individual stock reactions have been mixed, good earnings reports and outlooks have generally been met positively. Coke# and Pepsi# earnings bubbled up strongly and were well received by investors. Visa# said on its earnings call that travelers are crossing international borders again, leading to increased transaction volume. Conversely, UPS# said U.S. package volumes were down by 3% in the first three months of 2022, although pricing grew by 9.5%.
Last night Amazon# reported 7% revenue growth, its slowest in 7 years, along with higher costs for wages and transportation. Apple# posted solid growth in most business lines, but noted that supply chain pressures will persist for a while longer. We will see if they receive an icy reception, but it is likely that we will experience more market volatility ahead.
As long as population grows and productivity improves, the economy and corporate earnings can continue to grow. Wages are pressuring margins along with input prices such as commodities and fuel costs, but inflation is allowing for capture of rising costs. Procter and Gamble# said recently that customers are actually trading up to premium products (razors, detergent, etc.) in this environment. Go figure! Sherwin Williams, the paint company, is looking for double-digit revenue growth for the year after beating expectations for the first quarter. However, there comes a point where paint selling at $100 per gallon is too expensive and could lead to demand destruction. Good thing they are running a 25% off sale!
The chart above shows the annual price return for the S&P500 over the last 7 decades. We see mostly positive results, but some negative years, especially after a period of strong returns as we have seen in recent years. Short-range weather (and market) predictions are inherently tricky. A longer time horizon helps. It may or may not snow much this coming Winter (and hopefully we had our last frost in the Northeast last night), but next year it is a pretty good bet that Winter will be followed by Spring, Summer, and then Fall. Equities offer some hedge against inflation in the long run. In the short run, volatility creates a rocky backdrop for investing, but also reveals budding investment opportunities as valuations thaw out. As the blizzard lifts, hopefully this leads to fresh powder (nutaryuk) that will be good for driving the sled (piegnartoq).
Birthdays: Jerry Seinfeld turns 68 (not that there’s anything wrong with that), Eve Plumb (Jan from the Brady Bunch) turns 64, and both Andre Agassi and Uma Thurman turn 52.
Christopher M. Crooks, CFA®, CFP® – 610-260-2200