By Portfolio Manager, Paul Broughton
What seems to be the most anticipated recession ever still has not arrived, but its effect on the market is being felt today nonetheless. There has been a sense of foreboding and apprehension hanging over the market since the Fed started aggressively raising interest rates last year. The S&P 500 is down about 11.5% since peaking in early January of 2022. And since the end of April 2021, it has a total return of 2.4%, essentially “unchanged.” In other words, we have chopped sideways for the last two years. That does not sound positive, but it is worth putting into context to get a better understanding of where we are at currently given the relevant circumstances.
As one would expect, higher interest rates have been hitting economically sensitive areas of the market. Last year, new housing construction activity fell from over 1.7 million units at an annual rate to around 1.4 million, reflecting the surge in mortgage rates. More recently, shares of banks, transports, and semiconductors are down about 27%, 10% and 5% respectively since early February compared to the broad market’s decline of 0.3% likely due to fears of a potential recession.
Some company-specific earnings reports highlight the recent weakness in transports. United Parcel Service Inc. said annual sales will likely be at the low end of its guidance as U.S. retail sales
slow, weighing on demand for package deliveries. “In the first quarter, deceleration in U.S. retail sales resulted in lower volume than we anticipated, and we faced ongoing demand weakness in Asia,” Chief Executive Officer Carol Tomé said. And trucking and logistics company J.B. Hunt, a major freight carrier, said that its profit and revenue for the latest quarter declined more than expected in what the company called a “freight recession.” The company’s President Shelley Simpson said “To start, we’re in a challenging freight environment where there is deflationary price pressure for an industry that continues to face inflationary cost pressures.” What do these companies have in common? All deliver goods. Goods companies performed exceptionally well during the pandemic, while service companies retrenched sharply, as people stayed at home. That is all reversing, as people resume traveling, going to restaurants and to shows. So, goods producers and transportation companies have seen declines in demand.
Even though the recent weakness in banks, transportation and semiconductor stocks may be signaling concerns in parts of the U.S. economy, many market participants do not agree that a recession is imminent. This is primarily due to a very low unemployment rate reflecting the fact that many employers are still challenged in hiring workers and consumer spending remains healthy.
Indeed, while many are anticipating inflation to fall and that a recession is right around the corner, there are many data points that suggest that the economy continues to show resilience.
The iShares U.S. Home Construction ETF (ITB) is up 24.5% YTD compared to the S&P’s 7.3% return as the demand for housing remains durable – reflecting the very favorable demographics for continued demand of new housing stock. Our CIO, Chuck Lieberman, has been consistently positive on the favorable demographics for the homebuilding market over the last few years and remains so. Indeed, recent data implies that a recovery in housing activity is already underway. As well, consumers continue to spend. Recent earnings results from the payments companies show consumers willing and able to spend on travel, dining out, and entertainment. This rise in travel demand is even more striking despite the 17% rise in airfares over last year. This summer’s travel forecast is set to be the strongest in over 40 years.
Also worth noting is a company whose products touch a broad swath of the industrial economy – PPG Industries. They are a large manufacturer and distributor of paints, coatings, and specialty materials. The company reported strong quarterly earnings that exceeded expectations and raised their full-year earnings forecast. They kept their revenue forecast in-check in order to be prudently guarded about the rest of the year, but this doesn’t sound like a company that is seeing a downturn or slowing ahead. Why? PPG sells auto paints and auto production is recovering after a period of parts shortages.
The market’s modest returns over the last couple of years aren’t significant at face value, but when you consider the fact that they’ve been achieved, despite the most aggressive rate hiking cycle in over 40 years, they’re rather remarkable. And one could argue that the strength in the underlying U.S. economy has held up much better than expected given such a sharp increase in rates over the last year.
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