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Weekly Update 5/13/2022: Earnings Season Winds Down; Calm Begins to Return to Bond Market as Interest Rates Start to Stabilize

  • CACI International wins $138 million task order
  • Sysco releases earnings delivering excellent results beating profit estimates by over 25%; revenue estimates by over $1 billion; and they raise fiscal year guidance
  • Disney releases earnings beating expectations on strong Disney+ subscriber growth and high theme park attendance
  • Accenture Federal Services nabs $175 million NASA contract
  • General Mills agrees to acquire TNT Crust
  • International Business Machines signs strategic collaboration agreement with Amazon
  • Johnson & Johnson appoints CEO and CFO for new consumer spinoff

Domestic Economic News

We had key figures on inflation this week and that is where traders attention was focused. When the CPI and PPI figures were released Tuesday and Thursday respectively, equity indices were volatile but the fixed income markets seemed to process the information in a calmer fashion as yields across the curve came in. We interpret that as bond traders pricing in a slower economic environment down the road. Fixed income traders likely read it as the figures did not do much to sway the federal reserve from their current telegraphed path of near term rates hikes. Equity market volatility this week was clearly exacerbated by the meltdown in the crypto currency market and the associated deleveraging if people invested in those using margin loans. That is an area that we have scrupulously avoided and advised clients to do the same. Deleveraging helps explain why stocks like Apple or Anthem would decline on a particular day a large amount when there was no actual news related to the fundamentals of either company. It is a painful process to witness but eventually the process does stop and these stocks will catch a bid again – in particular from firms like us that do spend a good deal of time analyzing the fundamentals.

While annual measures of consumer prices cooled slightly from March the CPI release showed -- signaling a peak that economists expected – the details of a report Wednesday painted a more troubling picture as monthly figures advanced more than forecast. Services costs accelerated and inflation for most goods remained stubbornly high, underscoring the persistence and breadth of price pressures. Russia’s invasion of the Ukraine combined with Covid lockdowns in China further disrupted supply chains and pushed up prices for everyday essentials. That’s only going to make the task of taming inflation without tipping the economy into a recession more challenging for the Federal Reserve. Services inflation was strong across the board, keeping core inflation elevated even as the pandemic-related excess in the goods sector has begun to subside. That underscores how the Fed’s delay in raising rates has helped make inflation more sticky.

Producer prices increased more slowly in April than the previous month, and decelerated from a year earlier. The release bolsters indications that producer and consumer inflation may have reached a peak. The Covid lockdown in Shanghai threatens to exacerbate supply-chain pressures and inflation concerns, though slower economic growth in China could outweigh inflationary pressures by weighing on commodity demand and prices. Combined with slowing U.S. demand for goods, that could provide some respite from stubbornly high inflationary pressures. Headline PPI decelerated to 0.5% in April following a 1.6% gain in the prior month of March. The reading matched the consensus forecast. Core PPI came in below expectations, at 0.4% versus 1.2% previously and expectations of a 0.7% gain. The headline rate of change decelerated to 11.0% year on year (vs. 11.5% in the prior month of March). Core PPI slowed to 8.8% year on year, from 9.6% prior. Final-demand PPI services make up about 65% of the index weight and will become a more dominant factor. Price increases for final-demand goods didn’t slow in April, but cooling demand for goods should begin to limit commodity-price gains. The PPI, which measures the costs of producing consumer goods, directly affects retail pricing and is perceived as a good pre-indicator of inflationary pressures in the CPI. We do expect these numbers to come down in the second half of the year because the year-over-year comparisons will be with the elevated levels we are currently experiencing.

Interest Rate Insight and the Fed

The Ten-Year Treasury seemed to finally stabilize this week as in Tuesday trading it dipped back below 3%. The rapid rise in interest rates this year as put tremendous pressure on all areas of the bond market. Our view tends to be longer term in that there has been outflows through the early part of this year from bond ETFs and mutual funds, but that is likely to subside given that it has been sharp and we expect at some point rates to settle into a range. That should lend support to the fixed income market as there have been definite disruptions in both the corporate/credit market and in particular the muni market. While this is occurring it has opened up opportunities in both areas of the market. When the producer price figures came out Thursday we actually saw the demand for Treasuries as being strong that day at auctions and the yield on the U.S. Ten-year Treasury dropped below 2.85%.

There were several Fed members speaking this week. This can be summarized by the comments from Federal Reserve Bank of Cleveland President Loretta Mester, a voting member on the FOMC this year. She backs raising rates by a half point at the central bank’s meetings in June and July, as signaled by Chair Jerome Powell, and then seeing if officials need to move more slowly or quickly. “I think 50 at the next two meetings makes perfect sense. We’re going to have to then evaluate whether we need to speed that up. If we don’t see inflation moving back down, or if we see demand coming down faster than expected to we might be able to go a little slower.” She continued, “That will be a challenge, no doubt, because there are a lot of things affecting inflation now on the supply side that are not really effected by monetary policy but we’re really committed to doing what we need to do with our policy tools.” They seem to have a consensus on the Fed, at least judging from the several members that spoke this week as all the comments were similar.

Impactful International News

The UK economy unexpectedly contracted in March as the cost of living squeeze saw consumers cut back on spending. Gross domestic product fell 0.1% from February, when growth was flat, the Office for National Statistics said Thursday. It meant the economy expanded just 0.8% in the first quarter, less than the 1% forecast by economists. While the quarterly growth takes output back above its pre-pandemic level, it’s almost certain to mark the high point of the year, with the worst bout of inflation since the 1980s expected to see the economy rapidly lose momentum and possibly slide into recession. In March alone, the services sector and manufacturing both saw output shrink 0.2%. Consumer facing services dropped 1.8%. Bloomberg Economics expects the economy to contract in the second quarter after households were hit by a surge in energy bills and a tax increase in April. Further pain looms in October, when the Bank of England expects utilities to increase gas and electricity bills by a further 40%. The central bank last week forecast inflation would exceed 10% in October, five times its target, and policy makers are in the midst of one of their fastest ever tightening cycles to bring price gains under control. Still, that spell bad news for future growth, with the BOE predicting the economy will barely expand at all across 2023 and 2024. The Bank of England has been aggressive in combatting inflation which will help the situation but it does point to the unique challenges Europe in general is facing right now.

Beijing officials denied the city will be locked down and urged people not to hoard food as residents flocked to grocery stores amid growing concern the Chinese capital’s response to a persistent Covid-19 outbreak is about to be intensified. Speculation that Beijing will be locked down or put into a “quiet period” are rumors, Xu Hejian, a spokesperson for the Beijing municipal government said at a press briefing on Thursday. The city’s some 20 million residents don’t need to be nervous about food supply and deliveries aren’t halted, Xu said. “It is unnecessary to hoard food,” he said. “Residents don’t need to worry, the city’s operations won’t be affected.” The comments came amid speculation on Chinese social media that Beijing -- which has seen an escalating raft of pandemic restrictions the past few weeks -- may be subject to a lockdown like fellow megalopolis Shanghai. Beijing saw 36 new Covid cases in the 24 hours to 3pm local time, with just four of the infections in the community. Given the size of the city those numbers are very low. China’s strict Covid Zero policy sees all positive cases and their close contacts isolated in government quarantine sites. The strategy, which relies on a playbook of closed borders, quarantines, lockdowns and mass testing, is leaving the country increasingly isolated as the rest of the world lives with Covid and opens up. Shanghai has already been locked down for more than a month, with food shortages and delivery delays marking the first few weeks of restrictions. Most of that city’s 25 million residents remain under some form of lockdown, as officials seek to eliminate Covid from within the community, despite the increasing economic and social costs. This has contributed to supply chain issues globally and we look forward to these tight restrictions being lift in the not too distant future.

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