July 15, 2022
Don’t look now, but everything is dropping ─ and not just stocks and bonds. We’re looking at commodities, sentiment, home sales and real incomes, just to name a few. Some of the decreases, such as the change in commodity prices, are exactly what the Federal Reserve is looking for. Yet, investors continue to evaluate whether the Fed will go too far.
Home buyers have been feeling the pain of high prices over the last couple of years. In the last year alone, average home prices jumped 20%. Meanwhile, 30-year mortgage rates increased by 3%, with most of the increase happening in the last six months. This rate increase is significantly more than we’ve seen in past cycles. These two factors combined increase a monthly mortgage payment by about 65%! And that’s why home-buying sentiment is the worst since the early 1980s.
There is a saying in Economics 101, “The best cure for high prices is high prices.” The two-fold increase in home costs is already hitting the market. May existing home sales were 8% lower than the previous year. Retail sales also unexpectedly turned negative in May, falling 0.3% for the month. These are just cracks at this point but highlight the narrow landing the Fed is working with.
Commodity markets see the Fed-induced slowdown in the economy. Probably surprising to some, but many industrial metals and lumber prices hit their highs in March just as the Fed started raising short-term rates. The metals are 30% off the highs, while lumber is more than 50% lower.
The Fed is now doing the hard work we have been expecting. The initial increases in the Federal Funds rate were long overdue. Current economic conditions make a soft landing exceedingly difficult, but not impossible. Discussion of an impending recession has increased almost exponentially over the last couple of weeks. This has helped bring down longer-term interest rates. However, it is extremely unusual that earnings expectations have not fallen yet. Earnings historically fall 30% on average during recessions, with a range of 20% to 50%. While nobody knows when the market will bottom, it’s rare to reach bottom prior to earnings estimates being revised downward. The market will pay particularly close attention to executives’ comments regarding the future in second quarter earnings announcements.
While these are difficult times for investors, we’ve been through them before. Prudently navigating volatility provides better long-term returns for patient investors.
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