Weren’t we just talking about…

Mario Gabelli

It seems just last week we were talking about the markets moving to the highest level since last October. Well, as the old adage says, what goes up must come down. The markets broke their 13-week win streak as a plethora of information and events drove investors to pause and retreat, much like the Federal Reserve.

The S & P 500 lost 1.37%, the Dow Jones Industrial Average lost 1.67%, the Nasdaq slipped 1.43%, and the European MSCI-EAFA was off -3.34%. The good news? Year to date the S &P 500 is up 14.19% the DJIA + 12.34, the Nasdaq up, 21.21 and the MSCI-EAFA +18.07%.

Last week, investors parsed a slew of forward-looking data, as they worked to gauge the probability of a near-term recession. “The Conference Board Leading Economic Index (LEI), a bellwether of economic health, took center stage, and revealed a continued divergence between the economy and financial markets.” (JP Morgan commentary) Translation: Not good news for those who fear a recession.

The fall in the LEI index in May marked its 14th consecutive month of decline. This resulted, in a 6-month change of -4.3%; although somewhat imprecise, a negative reading on the LEI has been a decent signal of softer economic activity on the horizon. A closer look at the components of the index reveals that consumer expectations for business conditions emerged as the largest negative contributor, followed closely by the yield curve spread. The yield curve is now as inverted as it was during the regional banking crisis, indicating elevated risk to the economy.

Credit conditions aren’t expected to improve anytime soon either. The Federal Reserve will be doing its stress tests this week which should enhance bank lending caution as banks, particularly smaller ones, still face the risk of losing deposits and an increase in losses on their portfolio of securities as interest rates remain elevated for longer. On the flip side, building permits provided the largest positive contribution last month, spurred by a record low supply of existing homes. However, the sustainability of this uptick can be questioned given challenges around housing affordability.

With the Federal Reserve’s schizophrenia, they seem to be signaling indicating two more rate hikes before the end of the year, the risk is that a policy error triggers a recession is looming on the horizon.

We still believe a recession is in the cards and the game now is to minimize the effect to the U.S. economy. Complicating things is the near mutiny in Russia as Putin and Wagner are playing their game of power and control in the Ukrainian war. Interestingly, the markets seem to cautiously shrug off the implication and one truly does not know what is going on there, except to note, that the oil financing this war is still flowing and the price of oil is now $69.16, a drop of $16.92, from $83.26 the week before. However, a spike in oil prices due to an interruption in that supply could upend the Federal Reserve’s and the European Central Bank’s strategy for lowering inflation. Once again, energy is a prime driver of where inflation goes.

As such, we still expect the bull run to cautiously move forward as we still believe value will have its day. The inverted yield curve is tightening, meaning that long term rates are creeping up as short-term rates slide a bit lower.

Our belief in quality assets across both equities and fixed income, while maintaining a short-to-intermediate stance in duration continues to be justified.

To all we wish a very healthy and happy Independence Day.