18 May Where does the economy stand, and how will it affect your stocks?
You’ve likely heard & read about the Federal Reserve (“The Fed”), inflation, labor markets, and economic growth (GDP) recently. This is a lot to take in, especially when none of these topics help answer the pivotal question investors are asking: How will this economy affect my investment portfolio?
To set the stage – the S&P 500 stock index fell by -8.8% in April1, and the first two weeks of May have not seen substantial improvement. Now, markets are dangerously close to bear market territory. Armed with April’s economic data and the recent actions by the Fed, let’s take a quick look at the economy and how it could affect the stock market.
The April Data is In
The Bureau of Labor Statistics (BLS) reported that inflation (CPI) finally slowed in April. The U.S. annual inflation rate was 8.3% in April, which marked a decline from 8.5% in March. The March number marked a 41-year high. While April did show a decrease, it was lesser than the market forecasts of 8.1%. Of note – food prices jumped 9.4%, notching the most significant increase since April 1981.
The April employment number was strong. The economy added 428,000 jobs in April, and the unemployment rate was unchanged at 3.6%. The household survey found some softening in labor markets, as the labor force participation was 62.2%, the lowest in the last three months.
GDP turned negative in the first quarter, down 1.4%, as reported by the Bureau of Economic Analysis. Two consecutive quarters of negative growth indicate a recession.
What Does it All Mean?
Inflation fell, if only by – to use a technical term – a smidge. But it could be enough to call a peak. Falling inflation, combined with some potential softening in the labor market, could mean that we are seeing a nascent “soft landing.” Chairman Powell defines this as “getting back to 2% inflation while keeping the labor market strong.”
The strong labor market isn’t just putting people to work; it’s increasing the amount they get paid. Powell was clear that the current level of wage growth is one of the problems for lowering inflation. “wages are moving up at levels that are unsustainably high and not consistent with low inflation.”
However, there’s a lot on the positive side of the ledger. For example, household and business balance sheets are in good shape. The University of Michigan Consumer Sentiment Survey saw a big bump in April, reflecting that consumer pessimism is not set in stone.
The Fed Put is Likely Kaput
The “Fed Put” refers to the preference of the Fed in recent years to support the stock market through accommodative monetary policy. A loosening of monetary policy has often followed significant market declines
Based on Powell’s remarks, that kind of support doesn’t seem likely even if the broad stock market enters bear market territory. Inflation is his top priority, and when he says controlling inflation will “include some pain,” that’s part of what he’s likely talking about.
High inflation, negative GDP, and an unsupportive Fed. We should all sell stocks, right? We don’t think so. Even if we get a recession, no one can reasonably predict its duration or severity. Say you know the correct answer to those two factors – you still can’t predict how stocks will react.
The stock market is a forward-looking machine. Today, investors make decisions based on earnings and cash flow projections six months, twelve months, and twelve years into the future. You only get the full return of stocks by riding them out through their temporary declines. This is the risk-return tradeoff we all sign up for.
1 S&P 500 Monthly Return data from YCharts
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