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Downshifting economy — and inflation? – Week of May 30, 2022

One week of gains breaks a rare seven-week run.

Strategy and Positioning written by Steve Orr, Chief Investment Officer

index wtd ytd 1-year 3-year 5-year index level
S&P 500 Index 6.62 -12.22 0.40 15.97 13.46 4,158.27
Dow Jones Industrial Average 6.28 -7.85 -1.79 11.78 11.94 33,212.96
Russell 2000 Small Cap 6.49 -15.53 -16.05 9.19 7.77 1,887.86
NASDAQ Composite 6.85 -22.20 -11.04 17.87 15.42 12,131.13
MSCI Europe, Australasia & Far East 2.21 -12.21 -10.70 5.87 4.54 2,010.46
MSCI Emerging Markets -1.06 -16.26 -22.46 3.85 2.82 1,022.96
Barclays U.S. Aggregate Bond Index 0.72 -8.52 -7.71 0.36 1.32 2,154.38
Merrill Lynch Intermediate Municipal 1.99 -7.14 -6.70 0.34 1.51 297.27

As of market close May 27, 2022. Returns in percent.

 Strategy & Positioning 

 — Steve Orr 


A break

After seven weeks of pain, every U.S. index finished in the green last week. In recent notes, we set up the fundamental conditions for a bounce: 1) Weakening economic data in April would move Wall Street to a “Fed pause”; 2) Buybacks turned back on; and 3) End of month rebalancing by institutional funds. All were in play last week. Baring a tough trading day today, most indices should finish flat or slightly higher this month. 

Monthly readings from business and regional Fed surveys show an economy that has downshifted from Overdrive to a plenty-fast third gear. Higher prices and interest rates are the brakes. Richmond and New York Fed region surveys reported manufacturing, new orders and shipment times all fell, suggesting industrial firms are catching up. Prices paid and labor costs remain problem areas. 

During earnings season, a record $485 billion of buyback programs were either renewed or turned on for this quarter. While daily purchases of company shares are not a big factor in exchange volume, steady buying of shares by their issuers does lend support to markets. The median stock in the S&P 500 is down over 20% this year, and many companies are flush with cash. 

At its worst in the middle of the month, the S&P 500 was down 5%, and the NASDAQ down nearly 8.5%. At the same time, bonds were flat to about 0.25% higher and are now 1.5% higher. The spread in performance set the stage for risk parity and pension funds to rotate from bonds into underperforming stocks. Goldman Sachs estimated last week that the rebalancing trade could push over $30 billion into stocks. 

Lines and spreads

What about the technical picture? The intermediate and short-term trends are down. Our charts suggested that the S&P 500 and 600 small-cap indices could easily bounce 8% to 10%. Both indices put in a bottom on May 12th and the 500 flexed Bear claws dipping to 3,810 intraday on the 20th. That set up a nice double-bottom pattern for the chart line to bounce from. Three days and 6.7% later, both small and large cap indices are, for the moment, out of oversold territory. Much repair work remains to be done on the charts, however. 

The 50-day moving average for the S&P 500 sits 9.7% higher at 4,277 and the 200-day 14% higher at 4,456. The advance-decline line remains in a downtrend, suggesting more stocks finishing each day lower than higher. Volatility remains well below throw-in-the-towel levels; and sentiment, while bullish, has yet to bottom. All of which suggests to us a needed bounce, but a number of months will be needed above the recent lows to stabilize the market’s internals.

Is there a path to get back up to the moving averages and rebuild a Bull cycle? Certainly, but it starts with inflation. Consensus is building on Wall Street that inflation has peaked and will be heading toward 4% soon. We were in the “Spring Peak” camp back in January. Now we are not so sure that a straight path to 4% is the best case. Perhaps 4% to 5% by December appears reasonable to us today. Fed speakers are adamant that they only care about inflation and will raise rates high enough to choke off demand — that is economist speak for cause a recession. 

Gasoline is one example that needs to roll over. Production in the U.S. is running on schedule for summer blends. Inventories, already very low from last year’s reopening, are not being replenished fast enough. So, there is a supply issue for gasoline — and a greater supply problem for trucking diesel fuel. Memorial Day is the start of summer driving season and last weekend the national average, according to AAA, was $4.60 per gallon. That is a 40% increase this year. And in 2021 prices at the pump rose 35%. 

Too high

Exhibit A for high prices and higher rates is the housing market. New home affordability is softening demand. Ned Davis Research reports that the median new home price is 4.7 times higher than the median family income in the U.S. Higher mortgage rates plus high prices mean inventories of new homes are starting to rise. April’s new home inventory hit 444,000, the highest since 2008. Existing home inventory for sale is still riding at historic lows. Cutting new home inventories means lower prices for builders. Rising existing home inventories in a slowing economy could represent forced selling by homeowners who need cash. Neither is a good outcome. 

At least something lower

Weaker economic data has also pulled interest rates lower for the first time in months. Since August of last year, the Treasury curve has more than doubled in yield. The 10-year Treasury finished last summer at 1.19% and peaked in early May at 3.14%. Last Friday’s 2.74% represents a 0.4% drop. Shorter-term rates have also come down a quarter of a percent over the last two weeks. Rates are telling us that the economy may be slowing faster than the Fed realizes and that the Fed may need to slow down on the rate increases. Municipal bonds are one beneficiary: Tax receipts continue to come in above forecasts and D.C. is talking tax increases. Municipals yield anywhere from 90% to 102% of Treasuries, which is relatively cheap.


Stocks continue to search for a bottom. Bounces like last week can continue moving higher towards their moving averages which act as resistance. Another 3% to 5% higher is not out of the question. From there it is a waiting game on inflation and the Fed.

Expect news from D.C. this month. There are several proposals for Build Back Better and reconciliation involving tax increases. Despite the noise from D.C., inflation narratives and Fed speeches, to date 2022 is a typical midterm year. Fun.

  Upcoming Economic Releases: Period Expected Previous

FHFA House Price Index MoM

Mar 2.0% 2.1%
31-May House Price Purchase Index QoQ Q1 N/A 3.3%
31-May S&P CoreLogics Home Price MoM Mar 1.90% 2.39%
31-May Conf Board Consumer Confidence May 103.7 107.3
31-May Conf Board Present Situation May N/A 152.6
31-May Conf Board Expectations May N/A 77.2
31-May Dallas Fed Manuf Activity May 1.5 1.1
1-Jun ISM Manufacturing May 54.8 55.4
1-Jun ISM Prices Paid May 80.0 84.6
1-Jun ISM New Orders May N/A 53.5
1-Jun ISM Employment May N/A 50.9
1-Jun JOLTS Job Openings Apr 11,350,000 11,549,000
1-Jun Fed release Beige Book in prep for June 14-15 FOMC Meeting
1-Jun Wards Total Vehicle Sales May 14,500,000 14,290,000
2-Jun Challenger Job Cuts YoY May N/A 6.0%
2-Jun ADP Employment Change May 295,000 247,000
2-Jun Nonfarm Productivity Q1 -7.5% -7.5%
2-Jun Unit Labor Costs  Q1 11.6% 11.6%
2-Jun Initial Jobless Claims 28-May 210,000 210,000
2-Jun Continuing Claims 21-May N/A 1,346,000
2-Jun Factory Orders Apr 0.7% 2.2%
3-Jun Nonfarm Payrolls May 325,000 428,000
3-Jun Private Payrolls May 314,000 406,000
3-Jun Unemployment Rate May 3.5% 3.6%
3-Jun Average Hourly Earnings MoM May 0.4% 0.3%
3-Jun Labor Force Participation Rate May 62.3% 62.2%
3-Jun Underemployment Rate May N/A 7.0%
3-Jun S&P Global US Services PMI May 53.5 53.5
3-Jun S&P Global US Composite PMI May 53.8 53.8
3-Jun ISM Services Index May 56.3 57.1

Steve Orr is the Executive Vice President and Chief Investment Officer for Texas Capital Bank Private Wealth Advisors. Steve has earned the right to use the Chartered Financial Analyst and Chartered Market Technician designations. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary’s University School of Law. Follow him on Twitter here

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