Halftime 2022
In 2013, the Federal Reserve of the United States began publishing a report on the Economic Well-Being of US households. The survey includes modules on a range of topics relevant to financial well-being including credit access, behaviors, savings, retirement, economic fragility, and education. In 2021, self-reported financial well-being increased to the highest percentage in the nine-year history of this survey with 78% of respondents saying they’re “doing at least okay.” In addition, Gallup found that Americans’ satisfaction with “the way things are going in their personal life” neared a 40-year high in early 2022, even though their satisfaction with “the way things are going in the U.S.” neared a 40-year low. Derek Thompson of the Atlantic refers to this as the “Everything Is terrible, but I’m Fine” philosophy as people all over the world tend to be individually optimistic and socially pessimistic.
Unfortunately, the “I’m fine” portion of this philosophy has been starting to deteriorate. Consumer sentiment plunged in early June to the lowest on record, and for good reason. With inflation running north of 8%, gas prices averaging over $5 per gallon, and mortgage rates nearing 6%, consumers are becoming stressed, and some leading indicators suggest economic activity has been slowing. The financial markets have reflected this through the first half of the year with the S&P 500 Index, NASDAQ and the Aggregate Bond Index declining -20.0%, -29.2% and -10.6% respectively. The S&P 500 is now officially in bear market territory after its worst first half-year in over fifty years. In addition, the markets now look a lot different than they did 18 months ago. Back then, Zoom Communications had a larger market cap than Exxon Mobil while today, Exxon Mobil’s market capitalization is now ten times larger than Zoom’s. The formerly formidable FANG stocks have mostly corrected with Amazon down 36%, Netflix down 70%, Facebook (now Meta) down 52%, and Nvidia off 48% from their highs. Cathie Wood’s flagship Ark Innovation fund has fallen more than 60% from its February 2021 high, wiping out all its post-pandemic gains.
Talk of a recession has been palpable and according to the Atlanta Fed’s GDPNow Model, we may already be in one as inflation has started to negatively impact household spending. However, it’s not just consumers who are starting to feel this pain: input costs for the S&P 500’s constituents have experienced an increase of 14.7% year-over-year. A combination of higher labor, material, and transportation costs are causing margins to tighten and in response many businesses have started reducing their earnings forecasts and announcing hiring freezes & layoffs.
Recession or no recession, there’s no denying the world feels like it’s a mess right now. News outlets, journalists, and reporters are repeatedly comparing today’s tribulations to the 1970’s. To be frank, it’s hard not to see similarities. However, investment opportunities have also historically been created when the economy and/or markets decline and we have also observed some positive signs with supply chains starting to improve, and most input costs starting to stabilize or even decline. The unemployment rate is hovering around 3.6%, nearly matching the 50-year low of 3.5% just before the pandemic took hold in 2020. Consumer spending may be softening but remains robust. Consumption makes up 70% of the U.S. economy and while the savings rate has fallen, collectively consumers have never been in a better financial position with more than $17.9 trillion of cash and cash equivalents (Federal Reserve). In addition, the 12-month forward price-to-earnings ratio (P/E) for the S&P 500 Index is now about 15.5x, approximating its historical average and making the equity market much more attractively priced than when it reached a peak of 23x last year. The 70’s may have been the worst decade economically since the Great Depression but it was also when now legendary American businesses including Microsoft, Apple, and Home Depot were born. Similarly, we think the significant declines in the financial markets during the first half of 2022 have created opportunities for better returns going forward.
Mackenzie Edwards – July 2022