Pro Perspectives 7/1/22

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July 1, 2022

We talked yesterday about the economic recession that is now projected in the Atlanta Fed’s GDP model. 
With the addition of today’s economic data, this model is now projecting the contraction of the economy by 2.1% in the second quarter (which ended yesterday).  That follows the official contraction of 1.6% in the first quarter. 
Again, two consecutive quarters of contraction is by definition a recession. 
That said, stocks have been pricing this in.  Bonds have been pricing it in.  And now, some inflation data is beginning to roll over.  We looked at core PCE yesterday (the Fed’s favored inflation gauge).  It has declined three consecutive months.  
Add to this, in today’s manufacturing data, the price component came in softer, also in decline for three consecutive months.  Inventories are high, and with that, new orders have been slowing. Freight costs are coming down. 
Again, this moderation of exuberance in economic activity is good news. 
The cooling in the inflation data takes pressure off of the Fed – reducing the chances that the Fed will crush the economy with draconian rate hikes.  In fact, as I said last week, it’s possible that the Fed could be done.  That would be extremely positive news for stocks. 
With that in mind, we head into a long holiday weekend, and into the second half of the year, with stocks trading just under 16 times forward earnings.  That’s right at the long-term average P/E for the S&P 500.
So, that brings about the question of earnings.  What will the “E” of the P/E look like as we start seeing earnings reports from Q2?  Thus far, 18 companies have reported for their fiscal Q2.  Thirteen of eighteen have beat estimates. 
And according to FactSet data, Wall Street has a 12-month bottom-up price target on the S&P 500 that’s 30% higher than current levels.
That outlook would align with a mild recession, which we may have already seen.
Meanwhile, consumer and business balance sheets remain at (or near) record highs.  Debt service, as a percent of disposable income is near record lows.  Even a percentage point added to unemployment would still put it around historical norms.  And the housing market remains sustainable (more than half of mortgage holders have a fixed rate of 3.5% or less … and only 10% of mortgages have adjusted rate mortgages — and those ARMs have a fixed rate component, on average, for between 7 to 10 years).
With all of the above in mind, the stock market performance of the past six months has delivered us companies with strong balance sheets and predictable cash flows, that are now trading at single digit P/E’s
These broad-based declines are opportunities to buy high quality companies at a discount.  You can find some of the best value opportunities in this market by joining us in my premium portfolio service.  You can click here to subscribe
Have a great 4th!   
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