Weekly Investment Update (06/24/2022)

Fed Chair Powell Attributed the Rise in Long-Term Inflation Expectations to June’s 75 Basis Point Rate Hike

During the Federal Open Market Committee (FOMC) press conference, Chair Powell pointed to June’s preliminary reading of the University of Michigan five- to10-year inflation expectations report as a driver for raising interest rates by 75 basis points. The reading came in at 3.3%, which was up from 3.0% in May, and the highest level since May 2008. However, Friday’s data revealed that June’s final reading of the five- to 10-year inflation expectations was revised lower to 3.1%. Note that the survey is comprised of 500 U.S. households, and therefore, it is surprising that such a small sample size is driving Fed policy at the moment. Interest rate markets now stand split between a 25 basis point and 50 basis point rate hike at the July meeting. We would not be surprised to see pricing again increase 50bps to 75bps as consumers remain focused on higher energy prices; we anticipate this focus could actually increase in the heavier summer driving season and into midterm elections, where inflation and related policy are the main topic.

During his term, we have seen Chair Powell adjust his views with respect to the data on several occasions. For instance, last week, Powell mentioned that headline inflation is what matters for inflation expectations because “headline inflation is what people experience, they don’t know what core is.” Despite this statement, the Fed targets a core measure of the personal consumption expenditures basket. Back in 2018, Powell referenced trimmed mean inflation, a measure that trims the outliers on the high and low end of the data, as not showing inflationary pressure. As it has risen since then, Powell hasn’t mentioned this trusty gauge of underlying inflation.

Given the Fed’s shifting focus on various data, volatility is likely to remain elevated. As mentioned in last week’s Weekly Investment Update, Bessemer’s All Equity Model Portfolio has increased exposure to more defensive areas this year amid the higher volatility by adding exposure to healthcare, consumer staples, and utilities, as well as to energy and broader commodities, which have historically outperformed in higher inflationary environments.

Heaviest Week of Retail Selling Since September 2020

This past week, retail investors sold $633 million net in stock investments, the heaviest week of selling since September 2020, as negative sentiment surrounding markets continued to proliferate. While net inflows into ETFs were positive, outflows from single stocks eclipsed the positive inflows, while order flow in the options space was equally negative. At the single stock level, all sectors were aggressively sold as retail investors continued to shed equity exposure.

Retail support has softened this year from the highs of 2021, when injections of fiscal and monetary stimulus poured into the economy. While households have generally low leverage and strong balance sheets at the moment, higher inflation could weigh on household cash deployment into equities and possibly lead to more volatility in the markets if there are fewer buyers and/or retail investors continue to shed exposure given continued low sentiment. Despite the poor sentiment, earnings have generally held up well, and we believe that the higher-quality companies we predominately invest in with historically high margins, strong revenues, and significant free cash flow can weather the more challenging environment.

Equities Gained This Week as Investors Handicap Inflation Data, Economic News, and Fed’s Reaction

Retail selling and market sentiment notwithstanding, U.S equities still bounced higher on the week as stocks appear to have found some solid short-term support. The S&P 500 was up 5% for the week, the tech stock heavy NASDAQ gained 6%, and the Dow was up more than 4%. These positive moves were welcome following back-to-back prior weekly declines of more than 5%, the University of Michigan consumer sentiment survey for June hitting a record low of 50, and Powell’s hawkish vow of an “unconditional” commitment to bringing inflation back to target levels. This week marked just the second over the past 12 weeks since the start of April that major indices were in the black with positive returns. The jury is obviously still out on whether or not these gains portend a reversal and can be sustained or if forthcoming economic data and news lead to a resumption of selling pressure.