Since the Federal Reserve decided that inflation was no longer transitory around 18 months ago, they have been on a tear with interest rate hikes in hopes of killing inflation. Over that period, the same indicators continue to be under the microscope concerning the stock market and the economy: inflation, jobs data, corporate profits, and interest rates.
The most recent inflation data showed that the annual inflation rate in the US had fallen to 3% in June this year. That is a far cry from the 9% inflation data posted in June a year earlier. However, there are some things to note about that data; one is the high base effect of where prices were a year ago, and the other is that the volatile energy costs are way down from where they were a year ago. Core inflation data which moderates the effect on energy and food prices, posted its lowest number since October 2021, at 4.8%. Overall, inflation data is trending in the right direction.
Jobs reports for the quarter were robust but ended with a softer number than expected for June. During the quarter, an average of 244,000 jobs were added each month, and over the past year, the unemployment rate has been between 3.7% and 3.4%. That is very strong unemployment data when compared to historical terms.
Over Q2, companies report data from the previous quarter, so the corporate data discussed is Q1 performance. For the first quarter, corporate profits fell 5.9%. There are two ways to look at this data: 1. It is never good to see corporate profits fall; bad news. 2. It was forecasted that profits would fall 6.8%, which is good news and a surprise to the upside.
For most analysts, the ratcheting up of interest rates and high inflation over the last year was expected to hit companies harder than we have seen. The strong job data and recent wage growth was unexpected. As long as people remain employed and their incomes can support spending money, our economy hums right along. Making money and spending it is one thing Americans are great at.
Interest rates are the one economic factor that is actively manipulated and controlled. Sure, all of their decisions are based on the other variables, but ultimately the Fed makes decisions around interest rates that affect our economy. The Federal Reserve has a dual mandate: stable prices (keeping inflation in check) and maximum sustainable employment. Maximum is subjective, but sub-4 % unemployment is in the maximum wheelhouse.
Inflation has decreased considerably over the last 12 months, but having such strong jobs data gives the Fed more room to continue raising rates. Just as the Fed was too slow to increase rates on the front end under the guise of ‘transitory inflation,’ they have a long history of overshooting rate hike cycles.
As for the stock market, last year, it was forecasting higher interest rates in expectation of more significant negative consequences for companies this year. Most companies have successfully navigated the current economic landscape with higher than expected corporate profits. Better than expected in our world translates into higher stock prices. The broad US market index of the Russell 3000 is up over 15% during the first half of the year.
As we are sure you are, we are thankful for the recent increase in stock prices, but we are not out of the woods yet. A recession could be avoided for now if inflation continues to come down and interest rate increases cease after the expected July hike. The downside risk is that inflation pops back higher than expected, turning into higher interest rates and further hurting corporations and the consumer driving our economy. The uncertainty is why it is always essential to stick to the plan and remain prepared for a variety of outcomes.
As always, please reach out with any questions.
These are our thoughts, have a great Thursday.
-Austin Smith, CFA®, CFP®
*Numbers and Data Sourced from TradingEonomics, Reuters, Forbes and Search Solution Group