Mixed Messages

Let us start by saying that we are not anti-media. We believe that journalists provide the public critical information and serve an important role in holding both elected and corporate leaders accountable. That said, with investor uncertainty running high, commentary about the economic outlook is naturally getting more attention and occasionally creating dramatic headlines that are sometimes out of context. The following are primary examples:

1. The Chief Executive Officer (CEO) of a major electric vehicle company said that he “has a super bad feeling” about the economy and that the company will be reducing headcount and then he walked back those comments and stated that total headcount will actually rise
2. A CEO of a major U.S. bank said that the country is facing an “economic hurricane,” but that is unclear if it the hurricane will dissipate or end up being like Superstorm Sandy
3. The Fed Vice Chair said that “it is hard to make the case for a pause (in raising rates),” but followed up that beyond the next two Fed meetings “it is a bit difficult to say.”

Each of these comments moved markets but none of them are definitive statements. Instead, they suggest that both corporate leaders and policymakers are uncertain about the economic outlook and lack conviction. That simply mirrors the action we have seen in financial markets year-to-date with the stock market being an official leading economic indicator (see figure 1). In fact, investor sentiment has improved of late, not worsened, as those comments might imply (see figure 2).

This chart shows the News Economic Sentiment Index vs. S&P 500 year-on-year percent change from June 2019 to June 2022 year-to-date.

This line chart shows American Association of Individual Investors’ Investment Sentiment Index in percent bearish from June 2020 to June 2022 year-to-date.

We suspect that the recent uptick in investor sentiment (though still far from bullish) is reflecting initial signs that the U.S. economy is proving resilient. Not only did the May employment report show the economy adding 390,000 jobs, but the monthly ISM manufacturing and service sector business surveys showed the economy remaining solidly in expansion territory. While the economy has been showing clear signs of slowing after an economic boom in 2021, most economic signposts continue to point to an economy that is expanding at a rate of about 2.0% year-on-year (see figure 3). Yes, consumers are starting to feel the bite from inflation, weaker equity markets, and higher mortgage rates, but investors should not overlook the starting point with households’ cash levels as a percentage of disposable personal income rising from a pre-pandemic level of 323% to 397% by the fourth quarter of 2021 (cash levels rose $4.8 trillion in the United States during that period, see figure 4).

This line chart shows ISM Manufacturing New Orders Index vs. Real Gross Domestic Product in percent year-on-year from 2006 to 2023.

This line chart shows U.S. Household Cash Deposits as a percent of Disposable Personal Income from 1959 to 2023.

The path from here will depend on several factors like the war between Russia and Ukraine, crude oil prices, and the Federal Reserve, but what we are really witnessing is the supply-side and demand-side of the global economy trying to find a new equilibrium post-pandemic. On the supply-side, we need to see an easing of supply chain pressures. With the war limiting Ukraine’s ability to ship agricultural goods from its ports and China’s COVID restrictions holding back exports, it is unsurprising to see supply chain pressures still elevated. However, we do find it encouraging that things have not materially worsened (see figure 5). Should there be some resolution in Ukraine or a more permanent relaxation of COVID restrictions in China, then the odds of a soft landing might rise as inflationary pressures ease in the back half of 2022 (though we should acknowledge a potential inflationary offset from rising commodity prices should China’s economy reopen more fully).

This line chart shows the standard deviations of Citi's Global Supply Chain Pressures Index from 2019 to 2022 year-to-date.

On the demand-side, the Atlanta Fed’s real GDP tracker shows the economy expanding at about 1.3% in the current quarter with consumer spending potentially contributing about 3 percentage points to real GDP while changes in private inventories potentially subtracts 1.5 percentage points. Though we suspect that as time progresses, consumer demand may slow further. This could cause investors to become less focused on more backward-looking inflation data and more attentive to growth metrics as the year progresses. While resilient economic data are encouraging, we still see it as a double-edged sword that greenlights the Fed. Given that backdrop, we find it hard to justify an overly bullish view on equities at this stage.

We would like to see some signs that the Fed has the patience to allow a more natural rebalancing of supply and demand before taking on a much more aggressive stance on risk assets. Even if the S&P 500 did bottom on May 19th, we still think it is best to maintain a defensive tilt with a focus on stocks of quality companies with stable earnings growth and strong balance sheets and on fixed incomes assets that now have materially higher yields. While the odds of a soft landing may have increased ever so slightly over the past month, we still think it will take some time for post-pandemic supply and demand to find a more stable equilibrium.

What Should U.S. Investors Watch in the Week Ahead?

The big day to watch will likely be Friday when the Bureau of Labor Statistics will release the May consumer price index (or CPI) reading. The consensus is calling for headline inflation to slow from 8.3% to 8.2% year-on-year.

Back to top

Back to top

Back to top