Good News is Bad?

Stocks fell at the open (Dow -100 pts; SPX -.9%) on fresh evidence of a resilient economy. In this case, good news is bad because strength suggests the Fed may have to fight harder to slow growth & inflation. Interestingly, Treasury bonds fell for the same reason—a resilient economy negates the need for investors to pile into safe-haven assets.

Nearly all S&P 500 companies have reported second quarter results. In aggregate, they posted 13.7% sales growth and 7% profit growth. Those are OK numbers, though sales were clearly driven by prices hikes and profits were restrained by cost inflation. As a result, Wall Street forecasts for US corporate profits are beginning to come down. Estimates for 2022 peaked in July and have subsequently been ratcheted 1.3% lower. But many market strategists—like Mike Wilson at Morgan Stanley—believe they’re still too high given the fact that the Federal Reserve is actively engaged in slowing the economy to whip inflation. At the moment, consensus calls for about 7% profit growth both this year and next. Expect that to float lower over the next few months.

Fed Chair Jerome Powell recently warned that restrictive monetary policy could cause some “pain.” Chris Hyzy, CIO of Bank of America/Merrill Lynch, says investors don’t yet “have enough information…to understand the magnitude” of that pain.” He cautions against going to cash or panicking, but says it’s OK to be a little defensive here. We’re going through a process of resetting the economy and capital markets for perhaps the next 6-9 months. Once complete, it will set the table for a new economic cycle. “We’re bullish in the long-term.”

Filings for unemployment benefits (referred to as “jobless claims”) have declined for three straight weeks, remaining pretty close to pre-Covid levels. Layoffs remain low, and despite some evidence that hiring activity is slowing a bit, we really can’t escape the conclusion that the job market is still very tight. In this scenario, good news is in a way bad news because labor market resilience may force the Federal Reserve to take interest rates higher than expected in order to slow wage inflation. Hence, investors are hyper-focused on the labor market. Tomorrow’s Employment Situation Report will get a lot of attention. According to Bloomberg News, economists’ consensus forecast is for 318,000 new jobs, wage growth of about 5.3%, and the unemployment rate unchanged at 3.5%.

Speaking of strength, the Institute of Supply Management’s (ISM) survey of manufacturing business activity held steady last month. Economists expected a sharp decline in production, new orders, and hiring but none of that panned out. The only decline highlighted in the survey was “prices paid,” or input cost inflation. The big takeaway is that inflation has peaked and is now slowing.

All of this leads me to mention the dollar. The US dollar has appreciated nearly 15% against a basket of foreign currencies this year. This is odd, since slowing economic growth plus high and rising inflation typically equals a weak dollar. In my simple calculus, however, there are two good reasons why it does makes sense. First, our economy is turning out to be fairly resilient, as evidenced by second quarter earnings reports, the labor market and manufacturing activity. Second, everything is relative. A quick look around the world makes me think we’re the cleanest shirt in the laundry. China’s economy is slowing rapidly due to Covid shutdowns, government intervention in public companies, and a real estate market crisis. Europe is obviously hamstrung by a small war that’s causing outsized impact on energy & food security.