Stocks continue to move higher, in an apparent response to data showing a weakening of the economy and inflation which suggest the Federal Reserve will back off its interest rate hike regimen.
Interest rates are also moving higher, responding to concerns about additional monetary restraint. Stock prices are ignoring likely problems and assuming all is well.
Two landmark Supreme Court rulings have restored American’s founding principles. This bodes well for the future direction of our country and our economy.
A happy Fourth to all.
The Week That Was
Friday’s May report on consumer spending and income along with upward revised first quarter GDP data show the economy still moving ahead. Without convincing signs of progress on spending and inflation, the Fed will continue to apply yet more restraint.
Investors should consider the potential implications if increases in interest rates and the decline in the money supply last much longer than financial markets currently assume.
Things to Come
Today and Thursday, the July business surveys from ISM and S&P will estimate the strength of manufacturing and service company activity.
The S&P already has released its survey for early July, which showed considerable strength among service companies. June surveys were mixed.
In contrast to S&P, the ISM survey showed signs of slower growth among service businesses. We continue to look for more signs of weakening, which so far, are few and far between.
Friday’s job report will be the last one before the next meeting of the Federal Reserve. Private payroll jobs in May increased by a strong 283,000. The S&P business survey and initial unemployment claims for July point to another strong job growth month in the vicinity of 200,000. If so, the Fed will almost certainly be raising rates again at the end of the month.
Money, Money, Money
Though the stock markets don’t show it yet, money is tight. The 10-year T-Note is approaching our 4 percent target, and T-bill rates remain close to 5.4 percent. Monetary restraint continued through June, with our measure showing the money supply is down 16 percent over the past year, but up 20 percent from two years ago.
The economy is still riding on the excessive expansion of money prior to this past year.
We continue to expect the lagging impact of monetary restraint to hit both the economy and stock prices.
Market Forces
Stock prices rebounded sharply from the prior week’s decline. Renewed optimism over the
strength of the economy has the S&P500 up 21 percent from its low in October, but only down 7 percent from its peak at the beginning of 2022.
Investors continue to anticipate a soft economic landing and progress moving toward the Fed’s 2 percent target. The latest data point to a weakening in the economy and inflation. However, the progress in both areas is slower than the recovery in stock prices would indicate.
We continue to anticipate more economic trouble as businesses adjust to higher interest rates and a reduction in the money supply and credit. May wages and salaries are up at an annualized 8 percent, and consumer spending is up 5 percent from the first quarter of 2023. The impact of monetary restraint is not yet readily apparent.
The same is true for the Fed’s favorite consumer inflation measure. May’s core consumer inflation is up at a 6 percent annual rate from the first quarter, well above the Fed’s target.
The fixed-income markets have responded appropriately to recent signs of persistently high inflation.
Outlook
Economic Fundamentals: negative
Stock Valuation: S&P 500 overvalued by 16 percent
Monetary Policy: restrictive
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