The U.S. economy has been performing in a mixed fashion lately. According to the widely held definition (two consecutive quarters of contracting gross domestic product), the U.S. economy has technically entered recession territory. The headline news, however, may not reveal the full story. The July labor market report from the U.S. Department of Labor was unexpectedly strong, showing the U.S. economy added 528,000 nonfarm payroll jobs. Unemployment ticked down to 3.5%, and wage growth increased. Markets anticipate that this strength if it continues, will mean that the Federal Reserve will likely continue to raise interest rates to address continuing inflationary pressures.
Indeed, the Federal Reserve and its Federal Open Market Committee (FOMC) will probably remain in the spotlight for some time. The central bank implemented another 75-basis-point interest-rate hike at its July meeting, and now remains likely to tighten monetary policy further It should be mentioned that even the latest economic reports tend to lag present conditions. For some items, like commodities, prices are starting to soften, and this development could alleviate some inflationary pressures. It remains to be seen how much and how soon inflation may respond to the FOMC’s actions.
Meanwhile, earnings season is ongoing. At this writing, the majority of the corporations in the S&P 500 Index have reported their numbers. Although roughly 70% of these companies have managed to surpass analyst expectations, results have exceeded by only a narrow margin, and guidance for the rest of the year has been lackluster. In many cases, management teams have mentioned downsizing and reductions in spending.
Nonetheless, the stock market has been performing notably better. In July, the broader equity averages staged a constructive rally, and many stocks are better positioned from a technical perspective. A wide range of stocks is participating in the price performance. Investors have been rotating additional capital into the technology and consumer stocks that had already led the rally. In contrast, several months ago, the capital was tightly concentrated on energy and utility issues.
Conclusion: While equity valuations still seem reasonable, in the current environment we recommend investors remain cautious about adding big positions in stocks and continue to maintain a healthy allocation to cash. Given the complex market dynamics, volatility should be expected. Please refer to the inside back cover of Selection & Opinion for our statistically based Asset Allocation Model’s current reading.