Several Key Economic Engines in the U.S. Are Sputtering

The markets have seen a nice rebound over the past two weeks after a dismal start to 2022, even as the war rages on in Ukraine. In my view, this is nothing more than a 'relief rally'. The only way I see equities continuing to advance in the short term is if we see significant progress in ending the conflict in Eastern Europe. Even then, I think those additional gains would be short-lived. The main reason for this view is several key economic engines in the United States are sputtering and it is hard to see Europe at this point avoiding at least a minor recession. Somehow, a market priced at approximately 20 times forward S&P 500 earnings is unlikely to hold up in that sort of economic environment. The yield on the 10-year Treasury has moved up at a rapid pace to nearly 2.5% now, and the spread between it and the two-year Treasury yield has significantly narrowed. The yields between the five and 30 year Treasury yield just inverted for the first time since 2006. An 'inverted' yield curve often precedes recessions and a narrowing yield curve is not good for bank profits as well. The rapid back up in rates has the average 30-year mortgage rate approaching 4.5%, the highest levels since 2019. The sudden rise in interest rates is already having negative impacts on mortgage applications and sales of existing homes. Given the housing market is a key economic engine, this is another headwind for GDP growth. More concerning is the outlook for the consumer, given they account for over two thirds of the economy. The average consumer has lost nearly 3% of their buying power over the past year if you compared average wage gains of the past 12 months to recent CPI reports, and government statistics tend to undercount inflation in my view. The situation is worse for those that commute or rent given gasoline was up over 50% in past year before the invasion of Ukraine, while rents were up in the mid to high teens in 2021. This are key reasons in the last U of M consumer confidence sentiment survey more consumers mentioned reduced living standards due to rising inflation than any other time except during the two worst recessions in the past 50 years. Those being from March 1979 to April 1981, and from May to October 2008. Consumer sentiment hit its lowest levels since August of 2011. Consumers now expect a year-ahead inflation rate of 5.4%, the highest reading since late in 1981. 32% of consumers also expected their overall financial position to worsen in the year ahead. This is the highest levels ever measured in this survey that started in the mid-1940s. The situation is unlikely to get any better in the months ahead. The spike in crude has pushed gasoline to $4.25 a gallon nationally and diesel is now five bucks a gallon. Ukraine, Russia and Belorussia are all large exporters of key ingredients for fertilizers such as ammonia, nitrates, potassium and phosphate, not to mention crops like wheat. This means food prices will be heading higher in coming months and could quite possibly lead to significant starvation in poorer regions of the world in places like Africa. Even the POTUS has said that some 'food shortages' can be expected thanks to the conflict in Ukraine and western sanctions on Russia in response. Hardly an environment that supports current valuations in the market let alone further gains. I will continue to use the recent rebound and any additional rally to build up the cash positions in my portfolio. Darker times are likely ahead.

Several Key Economic Engines in the U.S. Are Sputtering

The situation is unlikely to get any better in the months ahead.

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