The month of July rewarded those investors who have stayed the course in this difficult year. The S&P 500 gained 9.22%, its best monthly gain since 2022, as investors shrugged off the highest inflation in over forty years, the Fed hiking interest rates by a substantial margin yet again, and the official marking of a recession. Small and mid cap stocks in the U.S. did even better (S&P 600 Small Caps gained 10.01% while S&P 400 Mid Caps gained 10.85%). The growth heavy NASDAQ gained 12.39%, while the international markets were comparative laggards. At the sector level, those sectors most beaten up this year heading into July were the best performers of the month, with Consumer Discretionary stocks gaining 18.9% and Technology stocks gaining 13.5%. Stocks weren’t the only bright spot in July—the Bloomberg U.S. Aggregate index of bonds gained 2.44% in July, propelled higher by falling interest rates at the longer end of the yield curve. The yield on the U.S. 10 Year Treasury closed June at 2.97% and fell to 2.67% by the end of July, although the short part of the yield curve rose sharply (the 3 month yield rose from 1.72% to 2.41%). Between economic news and earnings season getting underway, July contained plenty of noteworthy developments.

The first big piece of data was June’s Consumer Price Index (CPI) release on July 13. Headline CPI (which includes the price of food and energy) rose 9.1% in June on a year-over-year basis, the highest print for that indicator since November 1981. While one might expect this high inflation reading would send stocks lower, the S&P 500 finished positive on the day of the release and in fact most of the month’s positive return happened from July 13 going forward. This is likely because there seems to be a growing consensus that 9.1% represents “peak inflation” in the current environment, a theory supported by a significant sell-off in commodity prices since mid-June. The price of oil as represented by GSCI Brent Crude has fallen by 17.19% since its June 8 peak and 9.12% in the month of July. Other commodities like wheat, copper, cotton and corn saw July declines as well. All of this is good news if your primary concern is inflation, but it can also be indicative of a global economy slowing down as a result of higher prices and higher interest rates.

The big CPI release made it all but certain that the Fed would hike its Federal Funds Rate by another 0.75% at their two-day policy meeting later in the month, and sure enough that’s what happened on July 27. As with the CPI release, this news led to the counterintuitive result of a big stock market rally (the Nasdaq gained 4.06% on the 27^th). Fed Chair Jerome Powell’s press conference provided perhaps the most cause for stock gains, as he alluded multiple times to the Fed potentially slowing its pace of tightening going forward in order to see how well its actions to date have battled inflation.

If that wasn’t enough bad-news-is-good-news for the month, stocks rallied on July 28 after the Q2 GDP release confirmed that we’re officially in a recession. Yes, there has been plenty of hair splitting in recent weeks about what really constitutes a recession, but no one seems to argue the point when the economy is growing—the widely accepted definition is two consecutive quarters of GDP contraction, and that is what we now have. GDP shrank by 1.6% in Q1 and 0.9% in Q2. The S&P 500 gained 1.21% on this day. We wrote earlier in the year, following the inversion of the yield curve in April, that a historically reliable predictor of recession, the yield of a 10 Year U.S. Treasury falling below that of a 2 Year U.S. Treasury, suggested one might be on the way. One could argue that this relationship has broken down, as the yield curve didn’t invert until the recession had already begun. The yield curve has, since April, inverted again, and in fact the 2 Year yield spent time above the 30 Year for a good part of July. It remains to be seen what this indicates, but a subsequent recession in 2023 could be one possible outcome.

We say it all the time, but July really was a great month to remind us all that the economy and the stock market aren’t the same thing. Sure, what happens in the economy has significant influence on the stock market, and that is even true vice-versa to a certain degree, but that doesn’t mean that the two always move in lockstep. The stock market reflects what’s expected in the next 6-12 months, not necessarily what’s happening today, much less of what happened in recent weeks and months.

While July was an encouraging month for investors, it’s important to realize that we’re not out of the woods yet. Supply chain disruptions and commodity spikes could continue to foster inflation. This could force the Fed to continue hiking rates to an extent not signaled by Powell in his press conference. Even if inflation has peaked, it remains to be seen how its impacts on businesses and consumers will trickle out and continue hampering the economy and corporate earnings growth. On that latter point, according to FactSet, with earnings season under way and 56% of S&P 500 companies having reported thus far, the outlook remains mixed. 73% of companies that have reported have beat their EPS estimates, but those estimates had been revised lower and lower over the preceding quarter anyway. More companies have issued negative guidance than positive so far. But what’s interesting, and what will continue to be the primary focus when it comes to earnings, is that forecasts for earnings growth throughout 2022 continue to be positive. We discussed last month how the projected earnings growth for 2022 was 10%, even in the face of recession concerns, and that earnings typically see a significant decline in recessionary periods. Even with the updated guidance from a good portion of companies thus far, and even with a confirmed two consecutive quarters of GDP contraction, the latest aggregate analyst forecast for the S&P 500 in 2022 is still suggesting earnings growth of 8.9%. Is this just an unusual recession, or do earnings forecasts need to catch up to reality? The answer will likely have an impact on how the remainder of 2022 pans out for the stock market.

We’ll close this month’s newsletter the way that we have ended most of them: with a reminder that the key to long-term investing success is to have a plan and stick with it. If you had told investors at the beginning of July that the month would bring reports of even higher inflation, historically large monetary tightening and a confirmation of a recession, most of those investors would have predicted a negative month in the markets. This speaks to how difficult it is to reliably time market movements, even if we think we know what’s happening with the economy.

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