S&P 500 declines 2% as recession fears rise and consumer sentiment drops

I’ve been fully invested at the start of all major declines and I will be fully invested in the next one. I am not a market predictor, that’s for darn sure. – Peter Lynch 

The stock market was no better in June than it was in the previous five months of the year as the major averages closed lower last week and posted additional losses for the month. The S&P 500 Index declined about 2% for the week and has turned in its worst first half performance since way back in 1970. The benchmark was down more than 21% from its record high close in January while the Dow Jones Industrial Average was down more than 15%. Although there was no major catalyst last week for the continued weakness in stocks, there are lingering concerns over the possibility of a recession, high inflation, Federal Reserve interest rate hikes, the ongoing war in Ukraine and political risks. Consumer confidence has taken a major hit as evidenced by the Conference Board’s consumer confidence index in June, which fell nearly 5 points from the May reading and was less than expected as concerns grew that economic growth would weaken significantly in the second half of the year due to stubbornly high inflation. The fear of a slowdown in the economy caused the yield on the 10-year Treasury to fall to 2.88% while the 2-year Treasury yield dropped to 2.84%, indicating a very flat yield curve that could portend a recession. The yield on the 10-year Treasury had been as high as nearly 3.50% just a few weeks ago. In fact, the economy might already be in a recession as first quarter GDP was revised to negative 1.6% and the Atlanta Federal Reserve is forecasting an annualized decline of 1% in the second quarter. The technical definition of a recession is two consecutive quarters of negative GDP.  Unfortunately, as the Fed continues to tighten to bring inflation down, it runs the risk of overdoing it and causing the economy to slow even more. At a European Central Bank (ECB) forum last week, Fed Chairman Jerome Powell vowed to prevent inflation from taking hold longer-term and was committed to using all the Fed’s tools to bring inflation under control. To engineer a soft landing of the economy, the Fed must do a balancing act and could slow the pace of interest rate hikes if inflation is seen as having peaked and headed lower. This may mean the Fed must accept a slightly higher target rate of inflation of 3% or 4% instead of its long-time target of 2%.

Last Week

The core personal consumption expenditures (PCE) index in May, which excludes food and energy prices, rose 4.7% from a year ago, slightly less than expected and less than in April. This is the Fed’s preferred measure of inflation but remains elevated due primarily to high gasoline prices, which are averaging nearly $5.00 a gallon. Durable goods orders in May were strong and better than forecast. It was the 11^th increase in the last 13 months as nearly every major category showed a gain. The ISM manufacturing index in June was weaker than expected and the lowest reading since June 2020. Weekly jobless claims edged lower to 231,000, a decline of 2,000 but slightly higher than estimates.

For the week, the Dow Jones Industrial Average fell 1.3% to close at 31,097 while the S&P 500 Index dropped 2.2% to close at 3,825. The Nasdaq Composite Index slumped 4.1% to close at 11,127.

This Week

The June employment report is expected to show that about 260,000 new jobs were created and that the unemployment rate remains unchanged at 3.6%. The ISM services sector index in June is forecast to be slightly less than in May but still solidly in expansion territory that indicates continued growth.

The Federal Open Market Committee (FOMC) releases minutes from its monetary policy meeting in mid-June.

The only prominent company scheduled to report quarterly earnings in this holiday-shortened week is Levi Strauss & Co. Earnings season for the second quarter begins on July 14^th with the big money center banks.

Portfolio Strategy

The primary focus for investors this week will be the June employment report and the minutes from the most recent meeting of the Federal Reserve. Expectations are for the creation of about 260,000 new jobs, far fewer than the 390,000 jobs in May but still indicative of solid job growth and a strong labor market. A decline in the number of jobs could be viewed as a positive as it would mean that the Federal Reserve can be less aggressive in raising interest rates. Even job totals in the 150,000 to 200,000 range would be considered healthy as those were the numbers before the onset of the pandemic in 2020. Recent economic data such as housing starts, retail sales, consumer sentiment and manufacturing have been weaker than expected and the Federal Reserve needs to be mindful of these trends when it meets in late July. Minutes from the Fed’s last meeting will likely show that it plans to raise the federal funds rate by 75 basis points (a basis point is one hundredth of one percent), but the slowing economy may dictate a smaller increase to avoid a recession. Recent declines in the price of commodities have signaled a slowdown in the economy and the stock market has also priced in a significant weakening as well. The S&P 500 has now suffered two bear markets since the beginning of the pandemic in March 2020, but the benchmark has gained about 20% from the peak in stock prices before the first bear market began through June 24^th, about a week after the bottom of the second bear market. Although bear markets are painful, they tend to be short-lived at about 10 months in duration, compared to the average length of bull markets, which is about 3 years.  Many of the stock market’s best days during the last 20 years have occurred during a bear market and the first part of a bull market when it’s not evident that a bull market had begun. For this reason, the best way to weather the storm is to stay fully invested since it’s almost impossible to time a recovery in the stock market. History also shows that when the stock market is down more than 15% in the first half of the year, it tends to rally in the second half.