The outlook remains the inverse of Goldilocks.
The minimum decline investors should expect, if the Federal Reserve sticks to its current tightening agenda, is a 30% decline in the S&P 500 with that index so far down 24.5% from the high at the worst point on 17 June.
S&P500
Source: Bloomberg
A reminder that the Federal Reserve remains, for now at least, under political pressure to tighten, came with the release of the Pew Research Center poll in May, which shows that Americans remain far more concerned about inflation than any other issue.
A total of 70% of Americans view inflation as “a very big problem” for the country, followed by 55% as regards affordability of healthcare and 54% violent crime, according to a survey conducted between 25 April and 1 May.
Share of Americans view each of the following as a problem for the country today
Note: Conducted between 25 April – 1 May among 5,074 US adults. Source: Pew Research Center
Meanwhile, the latest ABC News/Ipsos poll conducted in early June showed that 71% of Americans disapprove of President Joe Biden’s handling of inflation, up from 69% in April.
As noted here before, the Biden administration seems to own the inflation problem politically as reflected in the polling data, though it is only fair to point out that the monetary expansion which sowed the seeds of the present inflation happened in March 2020, when Donald Trump was president, as a consequence of the Federal Reserve’s decision to engage in MMT-lite policies to address a pandemic.
If this is the overall context, the best hope for those owning growth stocks is that the focus in America in coming months switches from rising prices to a weakening economy.
For that could cause the political pressures to shift the other way.
And the empirical evidence shows that the Fed in the post-Volcker era has been increasingly sensitive to such political pressures.
It is certainly extremely easy for a Federal Reserve governor to talk hawkish, as Jerome Powell is now doing, when the executive and legislative arms of government want the Fed to be seen to be acting in such a fashion.
The market action that would cause focus on a slowing economy would be for the long end of the Treasury bond market to rally at a time when money markets are still expecting another 175bp of Fed tightening by the end of 2022, following the 150bp of rate hikes so far since March.
Meanwhile, the ten-year Treasury bond yield is slightly above the 40-year trend line in place since the beginning of the bull market in bonds in the early 1980s.
US 10-year Treasury bond yield (log scale, monthly)
Source: Bloomberg
Ukraine is Still a Risk to Food and Energy Prices
Meanwhile, the ongoing Ukraine conflict still has the potential to aggravate further the supply side pressures despite the recent correction in food and energy prices.
The World Bank Food Price Index declined by 4.7% in June after rising by 31% since September 2021.
World Bank Food Price Index
Source: World Bank
While the Brent crude oil price is down 17% from the recent high reached at the end of May.
Brent crude oil price
Source: Bloomberg
While the issues related to energy were well known even before the Russian invasion of Ukraine, in terms of the politically driven lack of supply, the impact on food and fertiliser prices has been dramatic since the launch of the conflict—which, by the way, shows for now no sign of ending.
The World Bank Food Price Index rose by 25% in the first five months of this year and was up 31% since September 2021 to a peak of 159 in May, though it has since declined by 4.7% in June.
Meanwhile, the World Bank Fertilizers Price Index surged by 30% over the two months to April and was up 151% YoY to a peak of 255 in April, though it has since declined by 13%.
World Bank Fertilizer Price Index
Source: World Bank
US Inventories Hold the Key to GDP Growth
Returning to the issue of the state of the American economy, it is worth looking in more detail at what the evidence for a slowdown is, which could cause Washington to become more concerned about the economy than inflation—a switch in focus which could in turn translate into a change in Fed language in coming months.
The first point to note is the role played by inventory accumulation in recent quarters’ economic growth.
Thus, in the third quarter of last year, inventory accumulation contributed to 2.2 percentage points or 96% of the total real GDP gain of annualised 2.3%.
The same pattern was clear from fourth quarter data, with inventory accumulation accounting for 5.32ppts or 77% of the total annualised 6.9% growth.
As for the first quarter of this year, when real GDP declined by an annualised 1.6%, the change in private inventories contributed to 0.35ppt or 22% of the decline.
Contribution to US real GDP growth (% QoQ saar)
Source: Bureau of Economic Analysis
Meanwhile, the Atlanta Fed’s GDPNow forecast model is indicating a slowdown on a YoY basis to 1.5% YoY in 2Q22, down from 3.5% YoY in 1Q22 and 5.5% YoY in 4Q21.
Atlanta Fed GDPNow model forecast for 2Q22
Source: Bureau of Economic Analysis, Federal Reserve Bank of Atlanta
It should be noted that this is lower than the trend growth since the financial crisis.
US real GDP rose by an annualised 2.3% from the post-financial crisis low in 2Q09 to 4Q19 prior to the pandemic.
The earlier inventory accumulation was presumably linked to expectations that consumers would spend more of the windfall generated by transfer payments.
Remember that American households were massive financial beneficiaries of the pandemic.
Americans have received US$2.7tn more in transfer payments since March 2020 compared with the pre-Covid levels as of May 2022, with personal savings increasing by US$2.2tn over the same period.
US personal income and savings
| US$bn, saar | Feb-20 (Pre-Covid) |
May-22 | Mar20-May22 (Average) |
Mar20-May22 Chg vs Feb-20 |
| Personal income (excl. transfers) | 17,287 | 19,424 | 17,803 | 1,162 |
| Personal current transfer receipts | 3,208 | 3,908 | 4,413 | 2,712 |
| Disposable personal income | 16,735 | 18,481 | 18,125 | 3,128 |
| Personal outlays | 15,342 | 17,475 | 15,741 | 897 |
| Personal saving | 1,392 | 1,006 | 2,384 | 2,231 |
| Personal saving/disposable income (%) | 8.3 | 5.4 | 13.2 | 4.9 |
Note: Personal income includes compensation of employees, proprietors’ income, rental income, interest and dividend incomes. Source: Bureau of Economic Analysis
Still, the household savings rate has now collapsed back to its lowest level since 2009.
This is despite the fact that Americans appear to have spent less than 30% of the windfall from stimulus cheques, according to New York Fed surveys.
US personal savings as % of disposable income
Source: Bureau of Economic Analysis
In this respect, part of this windfall will have been invested in the stock market, given that the bull market in digitalia, driven by Covid, clearly had a retail margin financing element.
That must be one explanation for the surprising weakness in US consumer confidence despite high nominal wage gains.
The University of Michigan consumer sentiment index declined from 65.2 in April to a record low of 50 in June.
University of Michigan Consumer Sentiment Index
Source: University of Michigan
Yet, average hourly earnings of private production and nonsupervisory workers rose by 6.4% YoY in nominal terms in June.
The other explanation, of course, is that wages, by some measures, are falling in real terms.
For example, real average hourly earnings of private production and nonsupervisory workers fell by 2.5% YoY in May.
US average hourly earnings for private production and nonsupervisory workers
Source: US Bureau of Labor Statistics
Meanwhile, the impact of falling stock prices, and indeed crypto prices, on the economy should not be underestimated, given the growing financialization of the American economy in recent years, the consequence of so many years of ultra-easy monetary policy.
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