Presented by Mark Gallagher

General Market News
• U.S. Treasury yields were down last week as expectations of a recession and a potential slowdown in rate increases from the Federal Reserve (Fed) were reflected in fixed income markets. Economic data releases suggested a slowing of the global economy. The housing sector showed signs of softening with the North American Homebuilders Index, housing starts, and existing home sales all coming in lower than expected. Initial jobless claims picked up; both Europe and the U.S. Purchasing Managers Index fell below 50, indicating expectations of economic contraction. The 2-year, 5-year, 10-year, and 30-year fell 15 basis points (bps) (to 2.99 percent), 18 bps (to 2.87 percent), 15 bps (to 2.78 percent), and 10 bps (to 3 percent), respectively.
• Global equity markets rallied last week, with bond yields coming down as central banks continue to examine policies to combat inflation. The softening data in the U.S. and Europe indicate inflation may be peaking and that central bank policy could be closer to the end of the tightening cycle. There were also sighs of relief in both U.S. and European markets. In the U.S., better-than-expected Tesla (TSLA) and Netflix (NFLX) earnings gave way for the potential for earnings to be more robust than initially expected. Thus far, the blended earnings growth rate for the S&P 500 sits at 4.8 percent versus 4.0 percent expected. In Europe, the Nord Stream pipeline was restarted on Thursday amid fears that Russia would shut gas off completely. That said, fears aren’t completely gone with another turbine slated for maintenance on July 26. This week will bring a slew of large tech earnings, the second-quarter gross domestic product (GDP) estimate, and the July Federal Open Market Committee (FOMC) rate decision.
• On Tuesday, the June housing starts and building permits reports were released. Housing starts fell 2 percent against calls for a 2 percent increase, while permits dropped 0.6 percent against calls for a 2.7 percent decline. Although these reports can be volatile on a monthly basis, this marks two months in a row with declining starts and three consecutive months with falling permits. Despite the recent decline in new home construction, starts and permits remain well above pre-pandemic levels, supported by low levels of supply of existing homes for sale and rising housing prices. Looking ahead, most economists expect to see a further slowdown in the housing sector due to rising mortgage rates.
• Wednesday saw the release of the June existing home sales report. Sales of existing homes fell 5.4 percent against calls for a more modest 1.1 percent decline. This marks five consecutive months with declining existing home sales. Low supply, rising prices, and rising mortgage rates have served as headwinds for faster home sales this year. The recent slowdown in sales growth brought the pace of existing home sales to its slowest level since national shutdown measures expired in spring 2020, highlighting the current challenges for the housing market.

Source: Bloomberg, as of July 22, 2022

Source: Morningstar Direct, as of July 22, 2022

What to Look Forward To

Wednesday will see the release of the FOMC rate decision from the Fed’s July meeting. The central bank is expected to hike the upper limit of the federal funds rate by 75 bps, which would boost the upper limit from 1.75 percent to 2.5 percent. The Fed, which started hiking rates in March, is expected to continue to increase rates throughout the rest of the year to try to combat high levels of inflationary pressure across the economy. Economists will also closely monitor the Fed’s news release and postmeeting news conference for hints on the future path of monetary policy.

On Thursday, the advance estimate for annualized second-quarter GDP growth is set to be released. Economists expect to see that the economy grew at an annualized rate of 0.4 percent. If estimates hold, this would be a relatively encouraging rebound in economic activity after a 1.6 percent annualized GDP decline in the first quarter. Personal consumption growth is expected to increase 1.2 percent on an annualized basis, down from a 1.8 percent increase in the first quarter but still in healthy expansionary territory.

Disclosures: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poor’s. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The Dow Jones Industrial Average is computed by summing the prices of the stocks of 30 large companies and then dividing that total by an adjusted value, one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. The Russell 2000^® Index measures the performance of the 2,000 smallest companies in the Russell 3000^® Index. The Bloomberg US Aggregate Bond Index is an unmanaged market value-weighted performance benchmark for investment-grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities with maturities of at least one year. The U.S. Treasury Index is based on the auctions of U.S. Treasury bills, or on the U.S. Treasury’s daily yield curve. The Bloomberg US Mortgage Backed Securities (MBS) Index is an unmanaged market value-weighted index of 15- and 30-year fixed-rate securities backed by mortgage pools of the Government National Mortgage Association (GNMA), Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (FHLMC), and balloon mortgages with fixed-rate coupons. The Bloomberg US Municipal Index includes investment-grade, tax-exempt, and fixed-rate bonds with long-term maturities (greater than 2 years) selected from issues larger than $50 million. One basis point is equal to 1/100th of 1 percent, or 0.01 percent.

Mark Gallagher is a financial advisor located at Gallagher Financial Services at 2586 East 7th Ave. Suite #304, North Saint Paul, MN 55109. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 651-774-8759 or at mark@markgallagher.com.

Authored by the Investment Research team at Commonwealth Financial Network.

© 2022 Commonwealth Financial Network®

Presented by Mark Gallagher

General Market News
• Last Wednesday, U.S. inflation numbers for the month of June were released and the Consumer Price Index (CPI) report exceeded expectations with an increase of 9.1 percent year-over-year. This upside surprise in prices is keeping the Federal Reserve (Fed) on its toes in advance of its July 26–27 meeting; some market participants are expecting the Federal Open Market Committee (FOMC) to increase rates by a full percentage point, while other Fed officials are trying to reign in those expectations. Fed Governor Christopher Waller currently believes a 75 basis point (bp) hike is the right move. “You don’t want to overdo the rate hikes. A 75 [bps] hike, folks, is huge,” Waller explained. “Don’t think because you’re not going 100, you’re not doing your job.” Waller didn’t rule out a 100 bps increase if last month’s remaining economic data announcements point him down that path, but that is yet to be seen. This week will bring numerous data releases related to housing, a significant component of inflation, so there is still much that could develop prior to next week’s Fed meeting. U.S. Treasury yields were down modestly last week; the 2-year, 5-year, 10-year, and 30-year fell 1 bp (to 3.10 percent), 9 bps (to 3.04 percent), 15 bps (to 2.93 percent), and 16 bps (to 3.09 percent), respectively.
• Markets sold off slightly last week as a higher-than-expected inflation report led to uncertainty around Fed policy. Wednesday’s CPI data came in with a 1.3 percent month-over-month increase against expectations for 1.1 percent. Energy, autos, airfares, and shelter drove the index higher. Following the report, expectations for a more rapid 100 bps federal funds rate hike increased dramatically. These expectations climbed near 90 percent at one point before St. Louis Fed President James Bullard—who is known as the most hawkish FOMC member—stated that he does not feel strongly for one at the upcoming meeting. As a result, stocks and growth (particularly technology, health care, and consumer discretionary) rallied on Friday. This performance was mixed with consumer staples, utilities, and tech as the three top-performing sectors for the week. Communication services, energy, and materials lagged as the President’s trip to Saudi Arabia led to speculation around higher production from OPEC countries.
• On Wednesday, the June Consumer Price Index report was released. Consumer prices increased more than expected, with headline prices rising 1.3 percent against calls for a 1.1 percent increase. On a year-over-year basis, headline consumer prices increased 9.1 percent, up from 8.6 percent in May and above economist estimates for an 8.8 percent increase. That’s the highest level of year-over-year consumer inflation in 41 years. Core consumer prices, which strip out the impact of volatile food and energy prices, increased 0.7 percent during the month and 5.9 percent year-over-year against forecasts for 0.5 percent and 5.7 percent increases, respectively. Despite the larger-than-expected increase in core consumer prices, this represents a modest slowdown in year-over-year core consumer inflation after a 6 percent increase in May.
• On Thursday, the June Producer Price Index report showed that producer prices increased more than expected, rising 1.1 percent in the month and 11.3 percent year-over-year against calls for 0.8 percent and 10.7 percent gains, respectively. Core producer prices, which strip out volatile food and energy prices, increased 0.4 percent in June and 8.2 percent year-over-year. Producer inflation has been driven by supply chain issues and rising material and labor costs this year, and the report showed that these headwinds continued to affect prices in June. Given still-high levels of consumer and producer inflation in June, the Fed is expected to spend the year tightening monetary policy to try to slow economic expansion and combat rising price pressure.
• On Friday, the June retail sales report was released. Retail sales increased more than expected, with headline sales increasing 1 percent against forecasts for a 0.9 percent increase. This was an encouraging rebound for retail sales growth after a 0.3 percent drop in sales in May, indicating that the slowdown was temporary rather than the start of a sustained slowdown. Core retail sales, which exclude auto and gas sales, increased 0.7 percent, up from the 0.1 percent drop in May and well above economist estimates for a 0.1 percent increase. Consumer spending held up well during the first half of the year despite headwinds created by inflation, stock market sell-offs, and worsening consumer sentiment, which is an encouraging sign that consumers remain willing and able to go out and spend.

Source: Bloomberg, as of July 15, 2022

Source: Morningstar Direct, as of July 15, 2022

What to Look Forward To
On Tuesday, the June housing starts and building permits reports are set to be released. These measures of new home construction are expected to be mixed, with permits expected to decline 0.9 percent and starts anticipated to increase 3 percent. These reports, which can be volatile on a month-to-month basis, are expected to come in well above pre-pandemic levels. Housing has been one of the best performing sectors since initial lockdowns ended in 2020, but the industry has begun showing signs of a slowdown this year, driven in large part by rising mortgage rates and a limited supply of homes for sale. If we see an increase in new home construction during the month, it would be an encouraging sign that home builders continued to break ground on new units, which, in turn, would help the supply-constrained market.

Wednesday will see the release of the June existing home sales report. Sales of existing homes are set to decline 0.2 percent after a 3.4 percent decline in May. On an annualized basis, sales of existing homes are set to fall to 5.4 million, down notably from the recent high of 6.5 million sales in January. Rising mortgage rates, a lack of supply of homes for sale, and rising prices have contributed to the slowdown in existing home sales growth. If estimates hold, it would mark the lowest level of existing home sales since the expiration of initial lockdowns, leaving sales near their pre-pandemic level. Given the fact that housing costs represent a large portion of consumer spending, the slowdown in sales growth may help slow home price appreciation and consumer inflation in the second half of the year.

Disclosures: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poor’s. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The Dow Jones Industrial Average is computed by summing the prices of the stocks of 30 large companies and then dividing that total by an adjusted value, one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index. The Bloomberg US Aggregate Bond Index is an unmanaged market value-weighted performance benchmark for investment-grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities with maturities of at least one year. The U.S. Treasury Index is based on the auctions of U.S. Treasury bills, or on the U.S. Treasury’s daily yield curve. The Bloomberg US Mortgage Backed Securities (MBS) Index is an unmanaged market value-weighted index of 15- and 30-year fixed-rate securities backed by mortgage pools of the Government National Mortgage Association (GNMA), Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (FHLMC), and balloon mortgages with fixed-rate coupons. The Bloomberg US Municipal Index includes investment-grade, tax-exempt, and fixed-rate bonds with long-term maturities (greater than 2 years) selected from issues larger than $50 million. One basis point is equal to 1/100th of 1 percent, or 0.01 percent.

Mark Gallagher is a financial advisor located at Gallagher Financial Services at 2586 East 7th Ave. Suite #304, North Saint Paul, MN 55109. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 651-774-8759 or at mark@markgallagher.com.

Authored by the Investment Research team at Commonwealth Financial Network.

© 2022 Commonwealth Financial Network®

Presented by Mark Gallagher

June Selloff Adds to Challenging Quarter for Markets
Equity markets experienced widespread selloffs in June as fears of a potential recession and continued high inflation weighed heavily on investors. This capped off a challenging second quarter for markets, as all three major U.S. indices ended the month and quarter down. The S&P 500 lost 8.25 percent during the month and 16.1 percent for the quarter; the Dow Jones Industrial Average lost 6.56 percent during the month and ended the quarter down 10.78 percent; and the Nasdaq Composite lost 8.65 percent in June and 22.28 percent for the quarter. The Nasdaq Composite saw the largest monthly and quarterly declines due to its heavier weighting on beaten down technology stocks.

These declines came despite improving fundamentals during the quarter. Per Bloomberg Intelligence, as of June 17, 2022, with 99.8 percent of companies having reported actual earnings, the average first-quarter earnings growth rate for the S&P 500 was 9.01 percent. This is up notably from initial estimates for a more modest 5.19 percent increase at the start of earnings season and represents solid quarterly earnings growth for the index. Over the long term, fundamentals drive performance, so this better-than-expected result in the first quarter was a positive sign for markets. Looking forward, analysts expect to see further earnings growth throughout the rest of the year.

Technical factors, on the other hand, were a headwind for U.S. equity markets during the month and quarter with all three major U.S. indices under their respective 200-day moving averages. This marks three consecutive months with all three indices finishing below this important technical trendline. The 200-day moving average is a widely followed technical indicator as prolonged stretches above or below can be a sign of shifting investor sentiment for an index. While it’s too soon to say if investors have soured on U.S. equities based on technicals alone, the second quarter’s technical weakness was a potential cause for concern and should be monitored going forward.

The story was much the same internationally during the month and quarter when concerns over inflation, interest rates, and a slowing global economy weighed on investors. The MSCI EAFE Index lost 9.28 percent in June, which capped off a 14.51 percent loss for the quarter. The MSCI Emerging Markets Index saw a similar 6.56 percent decline for the month and a 11.34 percent loss for the quarter. Technicals were a challenge for both international indices during the quarter, as both remained well below their 200-day moving averages for almost the entire period.

Even fixed income struggled as rising interest rates caused prices for previously issued bonds to fall. The 10-year U.S. Treasury yield started the quarter at 2.39 percent and rose to a high of 3.49 percent in mid-June before falling to end the quarter at 2.98 percent. The Bloomberg U.S. Aggregate Bond Index declined 1.57 percent during the month and 4.69 percent over the quarter.

High-yield fixed income also struggled; the Bloomberg U.S. Corporate High Yield Bond Index dropped 6.73 percent in June, which contributed to a 9.83 percent loss for the quarter. High-yield credit spreads rose from 3.40 percent at the start of the quarter to 5.87 percent by the end of June.

Recession and Inflation Spook Investors
The market underperformance in the second quarter was largely driven by investor concerns about inflation and the Federal Reserve (Fed)’s decision-making process. The Fed spent the quarter trying to combat inflation by tightening monetary policy through a series of interest rate hikes, and the central bank has made it clear that it plans on continuing to hike rates until there is sustained evidence that inflation is slowing. Higher interest rates from the Fed caused markets to reprice both equities and fixed income investments, which caused the declines that we saw over the quarter.

Investor concerns about a possible recession started to increase in June as economic updates showed signs of a potentially slowing economy due to high interest rates. Given the continually high levels of inflation and the Fed’s stated goal of getting prices under control as soon as possible, investors are concerned that company earnings may be negatively affected by a potential slowdown.

With that said, there were signs that the worst impact from inflation may be behind us (in June). We saw evidence that inflation is starting to slow due to improved supply chains and moderating energy costs. We also saw long-term interest rates decline toward the end of the month, which is a sign that investors are less concerned about long-term high inflation. Ultimately, while investor concerns surrounding inflation and interest rates caused market turbulence during the quarter, the worst phase may be behind us.

Economy Continues to Grow
Despite market selloffs, the economic data releases still showed signs of continuous growth. Hiring was strong throughout the month and quarter, with the May job report showing 390,000 added jobs. This represents a very strong month of hiring on a historical basis and was backed by the unemployment rate, which was 3.6 percent in May. This is largely in line with the pre-pandemic low of 3.5 percent and highlights the very real progress we’ve made in getting folks back to work following the end of initial Covid-19 lockdowns in spring 2020.

The healthy labor market and wage growth supported consumer spending growth during the month and quarter, although there were some signs of slowing spending growth in May. Both retail sales and personal spending growth slowed as consumer confidence dropped. There are very real questions about whether there is enough momentum from earlier in the year to keep consumer spending growing in the months ahead. We haven’t yet seen evidence of a sustained drop in consumer spending, however, which would be a potential cause for concern.

Business spending was also healthy throughout the month and quarter as business owners continued to invest in their businesses to meet high levels of demand. As you can see in Figure 1, core durable goods orders increased throughout the quarter and this proxy for business investment ended May well above pre-pandemic levels. Ongoing business spending during the quarter was an encouraging signal that business owners are still confident in economic expansion despite the headwinds from inflation and higher interest rates.

Figure 1. Manufacturer’s Now Orders: Durable Goods Excluding Transportation, 2012–Present

Source: Institute for Supply Management, Haver Analytics

While consumer and business spending continued to show signs of growth during the month and quarter, the same can’t be said for the housing sector. Housing was one of the best performing sectors early on in the pandemic as record-low mortgage rates and shifting home buyer preference for larger single-family homes caused a surge in housing sales and new home construction. With that said, 2022 has been another story as rising mortgage rates, lack of supply of existing homes for sale, and rising prices all served as headwinds for further sales growth. The average 30-year mortgage rate increased from 3.3 percent at the start of the year to 5.83 percent at the end of June, which weighed on prospective home buyers and the pace of housing sales.

The pace of existing home sales peaked at an annualized rate of 6.49 million sales in January but has dropped every month since and ended May at 5.41 million annual sales. This is largely in line with pre-pandemic levels and is a sign that the Fed’s attempts to slow the economy though higher rates are starting to have a tangible influence. While slowing housing sales growth has not yet had a notable impact on prices, the headwind from higher rates is expected to slow sales growth and price appreciation in the months ahead, which could help tamp down overall inflationary pressure.

Risks Remain, as Do Solid Fundamentals
The selloffs in June were a reminder that very real risks remain for markets and the economy, with the bulk of the concern surrounding inflation, interest rates, and the Fed. Despite market concerns about the turbulence from inflation and the central bank, it’s important to remember that economic fundamentals are sound and continued growth is still the most likely outcome in the months ahead.

The Fed’s plan to tighten monetary policy throughout the course of the year will continue to present a risk for markets, especially if the central bank surprises investors with the timing and size of further rate hikes. Additionally, while the pandemic’s effect on markets has diminished, this does still represent another potential risk factor that should be monitored, especially if we see another wave of case growth later in the year. Although geopolitical risks appear to have largely stabilized in June, the war in Ukraine and the ongoing lockdown in China could also negatively affect markets in the months ahead.

Despite persistent risks to markets and the economy, economic fundamentals here in the U.S. are positive and the most likely path forward is growth. The strong labor market and continued business and consumer spending are signs that core fundamentals are strong and that the economic recovery remains on track. While there are concerns of potentially slower growth later in the year due to higher rates, slow growth is still growth and this may serve to help combat inflation. Overall, while this was certainly a painful start to the year for investors, markets have largely priced in much of the negative news. We may be approaching a turning point as the news gradually gets better.

The pace of economic expansion is still uncertain, and we’re likely to see periods of turbulence. A well-diversified portfolio that matches investor goals and timelines remains the best path forward for most; however, you should reach out to your advisor to discuss your financial plan if you have concerns.

All information according to Bloomberg, unless stated otherwise.

Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Bloomberg Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Bloomberg government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Bloomberg U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.

Mark Gallagher is a financial advisor located at Gallagher Financial Services at 2586 East 7th Ave. Suite #304, North Saint Paul, MN 55109. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 651-774-8759 or at mark@markgallagher.com.

Authored by the Investment Research team at Commonwealth Financial Network.

© 2022 Commonwealth Financial Network®

Presented by Mark Gallagher

As we enter the second half of the year, the outlook might appear grim at first glance. Covid-19 continues to spread, both here and worldwide. Inflation remains close to 40-year highs, and the Federal Reserve (Fed) is tightening monetary policy to fight rising prices. The war in Ukraine is ongoing, and it threatens to become a long-term conflict. Midterm elections loom in the U.S. Looking at the headlines, you might expect the economy to be in very bad shape.

On the contrary, though, the news is largely good when you look at economic data. Job growth remains strong, and the labor market is still very tight. Consumers are out there shopping despite an erosion of confidence caused by inflation and high gas prices. Businesses, driven by consumer demand and the labor shortage, continue to hire as much as they can, and to invest when they can’t. In other words, despite the headlines, the economy remains not only healthy, but strong.

Unfortunately, markets are reflecting the headlines more than the economy; they’re down substantially from the start of the year. They tend to do this in the short term. A growing economy, however, generally supports markets, which gives us hope that the recent stabilization will continue, and even that markets might start to recover in the second half.

That isn’t certain, though, so the question is: With so much in flux, what does the rest of the year hold? As always, the answer is to look at the fundamentals, not the headlines.

Fundamental No. 1: The Economy
With so much momentum in place, the economy will keep growing through the rest of the year. Job growth has been strong and will stay that way given the high number of vacancies. At the current job growth rate of about 400,000 per month, and with 11.5 million jobs unfilled, we can keep growing at the same rate and still arrive at the end of December with more open jobs than at any point before the pandemic. This is the key to the outlook for the rest of the year.

When jobs grow, confidence and spending stay high. Confidence is down from its peak but is still above the levels of the mid 2010s, as well as those of 2007. With people working and feeling good, consumers will keep the economy moving through 2022. For businesses to keep serving those customers, however, they need to hire. This is proving difficult in the current climate. Another thing businesses need to do to continue on an upward path is to invest in new equipment. This is the second driver that will keep us growing through the rest of the year.

As we analyze the current state of the economy, there are two areas of concern: the end of federal stimulus programs and the tightening of monetary policy. Federal spending has been a tailwind for the past couple of years but is now a headwind. This will slow growth, but most of that stimulus has been replaced by wage income, so the damage will be limited. In terms of monetary policy, future damage is also likely to be limited because most interest rate increases have already been fully priced in. Here, the damage is real but is largely in the past.

The thing to watch will be net trade. In the first quarter, for example, the national economy shrank due to a sharp pullback in trade, with exports up by much less than imports. As with monetary policy, the good news is much of the negative impact has already happened. Data so far this quarter shows the terms of net trade have improved substantially and that net trade should add to growth in the second quarter.

Summing up, the foundations of the economy—consumers and businesses—are solid. The weak areas are not as weak as headlines would suggest, and much of the damage may already have been done. Although we have seen some slowing, slow growth is still growth. This puts us on solid ground through the end of the year.

Fundamental No. 2: The Markets
What does all of this mean for financial markets after a terrible start to the year? Will a slowing-but-growing economy be enough to prevent more damage? That depends on why the declines happened.

There are two possibilities to explain such a plunge: earnings or valuations. If it were an earnings-related decline, the market would have declined as expected earnings dropped. That is not the case here because earnings are still expected to grow at a healthy rate through 2023, and, as discussed earlier, the economy should support that. So, it must be related to valuations (the prices investors are willing to pay for those earnings). Here, we can do some analysis.

In theory, valuations should vary with interest rates. Higher rates generally mean lower valuations. Looking at history, this inverse relationship holds true in the real data. When we look at valuations, therefore, we need to look at interest rates. If rates hold, so should current valuations, and if rates rise further, valuations may decline.

Although the Fed is expected to continue raising rates, those increases are already priced into the market. Rates would need to rise more than expected to cause additional market declines. On the contrary, it appears rate increases may be stabilizing as economic growth slows. One such sign comes from the yield on the 10-year U.S. Treasury note. Despite a recent spike, the rate is heading back to around 3 percent, suggesting rates may be stabilizing. If rates stabilize, so will valuations—and so will markets.

In addition to these effects from Fed policy, rising earnings from a growing economy will offset any potential declines and will provide an opportunity for growth during the second half of the year. Just as with the economy, much of the damage to markets has been done, so the second half of the year will likely be better than the first half.

A Look Ahead
Now that we’ve analyzed the fundamentals, let’s return to the headlines. It was a tough start to the year with the news affecting expectations more than the actual economy, which, in turn, knocked markets hard. As the Fed spoke out about raising rates—and then followed through—markets fell further.

As we enter the second half of the year, despite the headlines and rate increases, the economic fundamentals remain sound. Valuations are now much lower than they were at the start of the year, and they show signs of stabilizing. Even the headline risks—inflation and war—are showing signs of stabilizing and may get better. We are nearing the point of maximum perceived risk, which means most of the damage is likely in the past, and the downside risk for the second half is largely already incorporated. That is not to say there is no risk, but the existing risks are unlikely to keep knocking markets down.

We don’t need to get great news to see the second half of the year turn out better than the first. We only need news that isn’t quite as bad. Growth will likely slow, but it will keep going. The Fed will keep raising rates, but maybe more slowly than expected. That combination should keep the economy and the markets on a positive trajectory. It probably won’t be a great finish to the year, but it will be much better than what we have seen to this point.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results.

Mark Gallagher is a financial advisor located at Gallagher Financial Services at 2586 East 7th Ave. Suite #304, North Saint Paul, MN 55109. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 651-774-8759 or at mark@markgallagher.com.

Authored by the Investment Research team at Commonwealth Financial Network.
© 2022 Commonwealth Financial Network®