Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.
Wednesday’s June Consumer Price Index (CPI) reading drove headlines for the week, with the latest survey showing overall inflation coming in at 9.1 percent year over year, hotter than Wall Street expectations of 8.8 percent. Core inflation, which excludes volatile food and energy prices, came in ahead of expectations at 5.9 percent but down from the recent peak of 6.5 percent in March of this year. Initial market reaction was predictably sour but more muted than the swings we’ve seen in the past, when inflation data surprised to the upside. Some of it may be that Wall Street is beginning to look past the headline numbers and is instead focusing on recent trends that are setting the stage for an unwinding of the inflationary pressures that have cast a shadow over the major indices.
For example, gasoline futures continue to tumble and are off nearly 25 percent from peaks hit in mid- June; the cost of shipping dry goods — as measured by the Baltic freight rate — is down 62 percent from pandemic highs; and prices for fertilizer, which are an input cost of producing food, have dropped 27 percent from recent highs. Perhaps the most telling as to where inflation is headed are spot commodity prices, which have a high correlation to year-over-year CPI readings. The index is down 20 percent from the highs reached last month.
The sense that inflation may be starting to loosen its grip is starting to make its way to Main Street as well, according to the latest results of the University of Michigan Sentiment survey. Respondents to the survey pegged their long-term inflation expectations at 2.8 percent. Recall that it was a preliminary reading of inflation expectations of 3.3 percent in early June that spurred the Federal Reserve to hike rates 75 basis points at its last meeting. The most recent reading continues a downward trend of expectations since then with a reading in late June of 3.1 percent.
While the data suggests inflation is receding, we acknowledge the coming months are likely to remain bumpy. The economy is slowing and could meet the technical definition of “recession” (two consecutive quarters of shrinking gross domestic product). However, we continue to believe consumers and corporations remain in a strong position to weather a potential contraction.
Wall Street wrap
As earnings season kicks off, we look forward to getting a front-row view of the strength of consumers and the cost pressures companies are facing as they issue their quarterly reports.
Resilient consumers. Large national and regional banks kicked off earnings season this week, with JPMorgan Chase, U.S. Bank and Wells Fargo leading the way. Each reported a generally bullish view of the strength of the consumer. While inflation is causing downward pressure on consumer confidence, the institutions report that it isn’t translating into lower spending or a meaningful hiccup in credit performance. Credit/debit spending was up 15 percent year over year in JPMorgan Chase’s credit card business, and travel spending remains strong across all income segments.
Similarly, Pepsi, the consumer staples giant, reported strong growth as consumers continued to buy products despite the company raising prices to offset rising input costs.
Sentiment remains soft. In addition to showing inflation expectations easing, the University of Michigan Sentiment survey points to continued caution by consumers regarding the economy. The latest reading edged up modestly to 51.1 from last month’s reading of 50. While higher, the latest number is at the second lowest level in the history of the survey. Much like the research we’ve noted in the past showing that low levels of investor sentiment have historically been followed by positive forward market returns, extreme lows in consumer sentiment also have a negative correlation with future market returns.
Importantly, the survey showed that the median expectation for change in household income in the next year was just .6 percent. The tepid expectations may signal lower wage pressures going forward.
The week ahead
In addition to the key economic reports listed below, we will continue to parse earnings releases, with an eye on quarterly results as well as changes to sales forecasts for the remainder of the year.
Monday: A week heavy on housing reports kicks off mid-morning with the Home Builders Index from the National Association of Home Builders. We’ll be focusing on inventory levels as well as looking for signs of how higher interest rates have impacted demand for new homes.
Wednesday: The latest numbers on existing home sales will be released mid-morning by the National Association of Realtors. The report, along with the new homes data out earlier in the week, should provide a clearer picture of the resiliency of demand in the face of higher rates as well as whether the rise in home prices has cooled.
Thursday: The Conference Board’s latest Leading Economic Index (LEI) survey will be a key release to watch for the week. Recent reports have shown decreases driven largely by a deterioration in consumer sentiment. We will be watching for variations in that trend and will be digging into each of the indicators to weigh their impact on economic growth going forward.
The central banks of both Europe and Japan will announce their latest rate policy decisions. Europe’s economy has shown to be more fragile than that of the U.S. in large part due to the war in Ukraine. We will be focused on statements from both banks on economic conditions and the path they see for rates going forward.
Friday: We’ll get look at the health of manufacturing and services in both the U.S. and Europe when S&P Global releases its Flash Purchasing Manufacturers Index reports for July. We’ll be watching to see how these two important economies are weathering the current inflationary environment.
Commentary is written to give you an overview of recent market and economic conditions, but it is only our opinion at a point in time and shouldn’t be used as a source to make investment decisions or to try to predict future market performance. To learn more, click here.
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As the chief investment officer at Northwestern Mutual Wealth Management Company, I guide the investment philosophy for individual retail investors. In my more than 25 years of investment experience, I have navigated investors through booms and busts, from the tech bubble of the late 1990s to the financial crisis of 2008-2009. An innate sense of investigative curiosity coupled with a healthy dose of natural skepticism help guide my ability to maintain a steady hand in the short term while also preserving a focus on long-term investment plans and financial goals.
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