An Economic And Market Environment Difficult To Evaluate

Power station and oil tank, petrochemical industrial plant at night and twilight sky view, technician industrial worker, engineer manager working in power plant.


An article I published just over a month ago looked at whether or not the economy is in recession and highlighted some of the difficulties in evaluating much of the economic data today. A stock market recovery appeared to be on the horizon after the June low before a sell-off in August. Another rebound appeared to be unfolding during the shortened Labor Day holiday week, with the S&P 500 Index gaining 3.61% over the 4-day period. Then, next Monday (09/12/2022) of last week, the S&P 500 index added another 1.06% return. That positive momentum hit a wall on Tuesday with the US August inflation report releasing CPI data. The report noted that inflation fell to 8.3% in August from an annual rate of 8.5%, but the S&P 500 fell 3.59% on Tuesday. Inflation rose on some key components of the report. Core CPI excluding food and energy rose to an annualized rate of 6.3% in August from 5.9% yoy in July. In addition, some service components saw an acceleration in inflation rates compared to the previous month.

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Energy has a large impact on headline inflation and inflation continues to fall in this category. Lower energy inflation is certainly positive; However, this is a category where the assessment of the sustainability of lower prices is unclear. The ongoing Russia-Ukraine conflict is one reason, but the Biden administration’s continued release of oil from the Strategic Petroleum Reserve is another. As the chart below shows, the fall in oil in the SPR has been significant and oil inventories in the SPR are now at levels last seen in 1984. These releases have most likely contributed to recent lower energy prices.

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State of strategic petroleum reserves on September 16, 2022

According to the Biden administration, they plan to replenish the SPR in the near future, which will at least put a floor on oil prices and potentially lead to a spike in energy prices.

FedEx (FDX) reported dismal earnings on Friday, sending the stock down 21%. The company cited weaker demand in Asia and Europe as a large part of the weakness. Some view FDX as guiding the global economy because of its intertwining of global economic activity with its parcel delivery business. Are FedEx results indicative of broader weakness in global economic activity? However, some say that FedEx problems are company specific. A recent article in forbes Remarks:

“The company needs (and has) a solution, and now it has to deal with rising costs (inflation), growing competition (such as improvements in the US Postal Service and Amazon (AMZN) delivery services), and a capital market that has become increasingly discriminatory in terms of risk and weak sales/earnings. (And that means that these too-distant “2025 financial targets” carry little weight. In fact, they imply a managerial laxity that increases risk even further.)”

Also the forbes The article highlights that FedEx says it will cut capital spending over the next year while maintaining its existing $1.5 billion share repurchase program. On the one hand, it can make sense to buy back shares when the company’s share price is low; However, FDX could receive more benefits if these funds were used to improve its operations.

Another sign of potential economic weakness is August imports arriving via the largest US port in Los Angeles. The Port of LA saw its biggest drop since May 2020 when inbound containers fell 17%. Import weakness is also reflected in broader global shipping data. The Baltic Dry Index (BDI) essentially measures global freight rates for dry bulk shippers. If the global demand for ships increases, the BDI also increases. The BDI peaked in October last year and has been trending down for the most part since an indication of lower ship demand as seen in the chart below.

Baltic Dry Index and S&P GSCI Commodity Spot Index as of 16 September 2022

Also shown on the chart above is the S&P GSCI Commodity Spot Index. The commodity index started falling in June and is an indication that demand is slowing. Scott Grannis, a former economist at Western Asset Management, recently wrote an article highlighting why inflation may already have peaked. Scott argues that inflation has likely peaked and believes the Fed may not be as tightening as the market’s collective wisdom believes. If the Fed slows its rate hike expectations, the article suggests that it could lead to a positive economic and market outcome. It is worth reading the article “The Strength of the Dollar Tells Powell to Relax”.

In summary, much of the economic data seems to indicate that the economy is slowing. This is not a surprise as Q1 and Q2 GDP numbers were negative, indicating negative economic growth. The analysis of the data is made more difficult by the disruption to the supply chain caused by the pandemic. If inflation is under control, as described in Scott Grannis’ article, and the Fed is more likely to pause than not, a benign environment could emerge towards the end of the year. As mentioned in a previous post, some of the strongest stock market returns follow mid-election years. As this is such a year, a post-midterm election rally could develop as seen below.

The calendar year is returned after the mid-election years

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Editor’s note: The summary bullet points for this article were selected by Seeking Alpha editors.

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