Weekly Update 1/27/2022: U.S. Economy Expands at Healthy Pace in Fourth Quarter

CACI International wins a $284 million contract from the National Security Agency (NSA); they release earnings producing another solid quarter with a revenue beat; additionally they announce new $750 million share buyback program
Microsoft announces a multi-year, multi-billion dollar investment in OpenAI; company beats profit estimates on strength in its Azure cloud services business
Disney 'Avatar: The Way of Water' tops $2 billion in global box office collections
Johnson & Johnson releases earnings beating profit estimates and raises 2023 guidance
Travelers releases earnings beating revenue expectations on strong net written premium growth
Raytheon releases earnings beating expectations and announcing a restructuring of their defense businesses
Automatic Data Processing, AT&T, Elevance Health, CACI International, IBM and T. Rowe Price all release earnings beating expectations
Boeing releases earnings demonstrating strong deliveries and free cash flow in their fiscal fourth quarter
Dow releases earnings missing estimates and announces job cuts
Visa releases earnings solidly beating expectations on a continued recovery in global travel

Domestic Economic News

The US economy expanded at a healthy pace in the fourth quarter, though signs of slowing underlying demand mounted as the steepest interest-rate hikes in decades threaten growth this year. Gross domestic product increased at a 2.9% annualized rate in final three months of 2022 after a 3.2% gain in the third quarter, the Commerce Department’s initial estimate showed Thursday. About half of the GDP increase reflected inventory growth, while government outlays matched the biggest gain since early 2021. Personal consumption, the biggest part of the economy, climbed at a below-forecast 2.1% pace. The mixed report suggests that the Federal Reserve still has a path to a soft landing with officials set to further downshift their rate increases next week and debate when to pause. Their preferred price gauge rose at the slowest pace in two years, while a separate report showed unemployment filings remained near historic lows. Initial weekly jobless claims came in at 186,000 versus the estimate for 205,000.

The data showed some signs of stress for American consumers whose wages have failed to keep up with inflation and continued to encourage them to draw down savings accumulated from government pandemic-relief programs. The burden of elevated prices and higher borrowing costs is mounting, pointing to a tenuous outlook for the economy. “When we look at what’s happening with the consumer, which is the backbone of the US economy, we are seeing a clear loss of momentum,” Lindsey Piegza, chief economist at Stifel Nicolaus & Co. in Chicago, said on Bloomberg Television. “Without the consumer happy and healthy out in the marketplace, we simply cannot expect to maintain positive growth, let alone more robust growth similar” to the end of last year, she said. We would tend to agree with her comments. A key gauge of underlying demand that strips out the trade and inventories components — inflation-adjusted final sales to domestic purchasers — rose an annualized 0.8% in the fourth quarter after a 1.5% gain. Final sales to private domestic purchasers climbed just 0.2%, the weakest since the second quarter of 2020. Consumer spending on services drove the economy to solid growth in the fourth quarter, but the good news ends there. Two measures of underlying activity that strip out volatile components — including trade, inventory swings, and government spending — showed considerably milder growth.

US business activity contracted for a seventh month, though at a more moderate pace, while a measure of input prices firmed in a sign of lingering inflationary pressures. The S&P Global flash January composite purchasing managers index rose 1.6 points to 46.6, the group reported Tuesday. Readings below 50 indicate falling activity. The gauge of input prices climbed for the first time since May. While the improvement in the composite measure of output at factories and services providers was the first in four months and points to a slower rate of deterioration, the gain in the price index indicates businesses are still contending with rising costs for labor and some materials. The Federal Reserve’s aggressive efforts to bring down inflation are beginning to spread across the economy, with higher borrowing costs helping to restrain demand. The S&P Global composite data showed a fourth-straight month of shrinking orders. “Companies cite concerns over the ongoing impact of high prices and rising interest rates, as well as lingering worries over supply and labor shortages,” Chris Williamson, chief business economist at S&P Global Market Intelligence, said in a statement. “The worry is that, not only has the survey indicated a downturn in economic activity at the start of the year, but the rate of input cost inflation has accelerated into the new year, linked in part to upward wage pressures, which could encourage a further aggressive tightening of Fed policy despite rising recession risks,” Williamson said.

The US figures stand in contrast to the euro area, where S&P Global data showed an unexpected return to growth and added to evidence the region may avoid a recession. The group’s measure of business activity at US service providers contracted for a seventh month. The gauge of new business continued to shrink, though it climbed to a three-month high in a sign demand is stabilizing, albeit at a depressed level. Manufacturing activity shrank for a third month and remains near the weakest since May 2020. The factory employment gauge dropped below 50 for the first time since July 2020, while measures of production and orders both shrank - though they improved slightly from the end of 2022. In addition to the firming of input prices, the composite prices-received gauge held steady and continued to show growth. It marked the first time since April that the measure failed to cool. On a more encouraging note, output expectations for the next six months rose to the highest since September, indicating companies are more sanguine about the outlook for demand.

We have all read bits and pieces on the importance of shipping costs and the contribution to inflation due to the bottlenecks caused by the COVID pandemic so we thought we would share some interesting insights on the subject this week. The pandemic-era surge in shipping costs was a “smoking gun” that foretold the global inflation spike, and the sharp drop in maritime-freight expenses since peaking last year will contribute to an easing in price pressures, a former International Monetary Fund official said. World container rates climbed more than sixfold by October 2021 from pre-Covid-19 levels, and the increase was “a canary in the coal mine for the persistent rise in inflation” seen in 2022, Jonathan D. Ostry, a professor at Georgetown University and the former acting director of the fund’s Asia and Pacific department, said in a post on the fund’s website Tuesday. A study undertaken by Ostry and four colleagues examining the link between shipping costs and prices suggests that a doubling of maritime-transport expenses caused inflation to increase by roughly 0.7 percentage points. “While skyrocketing food and energy prices were making headlines, the surge in shipping costs seemed to pass largely under the radar, despite its potential inflationary impact,” Ostry wrote in the IMF post on the study. “Given the actual increase in global shipping costs during 2021, we estimate that the impact on inflation in 2022 was more than 2 percentage points — a huge effect that few central banks would dismiss.” Ostry noted that some inflation drivers weren’t foreseeable or were difficult to predict, such as supply-chain disruptions, commodity-price increases owing to Russia’s invasion of Ukraine, and the unwinding of pandemic-era savings that boosted demand. “But while policymakers may get a pass for not factoring into their decisions what was unknowable a year ago, they should be held accountable for missing known drivers of inflation, especially those that pointed to enduring price pressures.

We at SGK like many have been critical of the Fed as it appears clearly evident that the Fed has had to hike interest rates further to make up for its delayed start. Recession risks are very plausibly larger as a result, as are the adverse global spillovers from Fed policy. The cost of shipping a container from Asia to the US peaked at $8,585 in March last year and has since plummeted to $1,200 — the lowest since 2018, according to an index compiled by Drewry Shipping Consultants. With the pandemic spike in shipping costs over, the research by Ostry and his colleagues suggests most of its inflationary impact has already been seen. That is good news indeed! The estimates are symmetric, such that declines in shipping costs would tend to bring inflation down in the following year, which implies that the plunge in maritime-transport expenses in 2022 will contribute to a reversal of inflationary pressures, Ostry wrote. “Shipping costs’ role as a driver of global inflation is under-recognized — this needs to change,” he said. “Shipping-cost shocks can alert central banks tasked with ensuring price stability of dangers ahead and help them reduce the risk of once again falling behind the curve.” It’s clear to us the Fed needs to expand its scope of indicators and be more forward thinking as opposed to strictly being reactionary. They keep citing the inflationary shocks of the 1970’s and this is not a 1970’s style economy - a lot has changed and the Fed needs to get with the program!

Interest Rate Insight and the Fed

Fed policy makers are in the quiet period prior to their meeting next week. Given as of late they seem to thrive on public appearances with basically absolutely nothing new, productive or constructive to say we at SGK are now calling this the “Welcome Period” as opposed to the better known “Blackout Period” prior to their meeting. So we will offer an alternative highlight this week. US Treasury Secretary Janet Yellen said she’s encouraged by progress on inflation, with energy prices and supply-chain issues easing across the globe even as the US labor market remains strong. “We’re seeing those supply-chain problems significantly mitigate, inventories are being built, shipping costs have come down,” Yellen told reporters after visiting a community health center in Lusaka, Zambia’s capital. “And so that part of inflation is no longer really contributing very significantly.” Several measures of inflation have shown encouraging signs in recent weeks, including declines in the consumer price index, which fell to 6.5% in the year through December, off its high of 9% in June. Producer prices have also declined faster than expected. In response, Treasuries have surged, with investors betting the Federal Reserve will stop raising rates and begin reducing borrowing costs sooner than policymakers are currently projecting. Yellen also said that goods prices moved down late in 2022 and that she expected housing inflation — a particularly strong contributor to price pressures in the second half of the year — to cool by mid-2023. “Over the next six months, that should largely cease boosting US inflation,” she said. “I do think in the US we’re continuing to see a strong labor market and progress on inflation. And so those are very helpful signs.” Yellen was on a three-stop Africa trip aimed at boosting US ties with the continent. She was set to hold discussions later Monday with Zambian President Hakainde Hichilema, with the country’s debt woes being the central focus.

The Federal Reserve’s preferred inflation measures eased in December to the slowest annual paces in over a year while consumer spending fell, helping pave the way for policymakers to further scale back the pace of interest-rate hikes. The personal consumption expenditures core price index, which excludes food and energy, rose 4.4% in December from a year earlier, Commerce Department data showed Friday. The overall gauge climbed 5% year-over-year, still well above the Fed’s 2% goal but both were the slowest paces since late 2021. From a month earlier, the core gauge — which Fed Chair Jerome Powell has stressed is a more accurate measure of where inflation is heading — was up 0.3%. The overall PCE price index increased 0.1%. Both were driven almost entirely by services as goods disinflation continued. Personal spending, adjusted for changes in prices, dropped 0.3% in December. Inflation-adjusted outlays for merchandise fell 0.9%, while spending on services stagnated, the first month without an increase since January 2022. The median estimates in a Bloomberg survey of economists were for a 0.3% advance in the core PCE price index and for no change in the overall measure on a monthly basis. Stock futures pared losses after the report while Treasury yields retreated slightly. The figures added to mounting evidence that the worst bout of inflation in a generation has passed as the Fed’s aggressive tightening campaign works its way through the economy. Officials are widely expected to once again slow the pace of rate hikes, to a quarter point next week, and will discuss how much higher they need to go to ensure prices are cooling for good.

Impactful International News

Ireland and the UK have a shared determination to secure an agreement on post-Brexit trading arrangements, Irish Finance Minister Michael McGrath said following his first meeting with Chancellor of the Exchequer Jeremy Hunt on Thursday. Talks on trading for Northern Ireland have reached a new level and there’s a very good atmosphere, though there are still issues that need to be resolved, he said in an interview with Bloomberg. “We discussed at a high level our objective of what we’d like to see by way of an outcome and a need for an agreement,” McGrath said. European Commissioner Maros Sefcovic and his team are “very anxious to secure agreement to bring a final settlement to this issue,” he added. Expectations of a deal have been building in recent weeks, since the European Union agreed to use a real-time UK database tracking goods moving over the Irish sea border — a development that lays the groundwork for a broader customs accord.

An agreement on the Northern Ireland Protocol – which avoids a land border on the island of Ireland, effectively placing a frontier in the Irish Sea and allowing Northern Ireland to remain in the EU single market — would resolve a drawn-out dispute between the UK and the bloc. Dublin’s focus regarding the protocol is to ensure an all-Ireland economy, so that trade can flow freely across the land border “in the interests of the economies north and south,” McGrath said. He added that there’s no timeline in place for an announcement.

IMPORTANT DISCLOSURE INFORMATION

Please remember that past performance is no guarantee of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Steigerwald, Gordon & Koch, Inc. [“SGK”]), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from SGK. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. SGK is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the SGK’s current written disclosure Brochure discussing our advisory services and fees is available for review upon request or at www.sgkwealthadvisors.com. Please Note: SGK does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to SGK’s web site or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please Remember: If you are a SGK client, please contact SGK, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Unless, and until, you notify us, in writing, to the contrary, we shall continue to provide services as we do currently. Please Also Remember to advise us if you have not been receiving account statements (at least quarterly) from the account custodian.