Assessing geopolitics, consumer sentiment, inflation, earnings and the Fed’s next move.
How many of you remember the musical “Annie”? Set during the Great Depression in 1933, little orphan Annie is taken in by America’s richest billionaire, Oliver Warbucks, to improve his public image. Annie ends up winning his heart, but the path to her becoming his adopted daughter is nearly thwarted by the villainous orphanage matron Miss Hannigan, her con artist brother Rooster and his girlfriend Lily St. Regis.
At one point, the villains concoct a plot to steal Annie and extract money from Warbucks. They belt out the shameless lyrics to the song “Easy Street”. It’s a “place that’s like no other/You got to get there before you die/You don’t get there/By playing from the rule book/no, no, no/You stack the aces/You load the dice.”
Spoiler alert: There is no “easy street” in the end as truth and good prevail. Miss Hannigan ends up having a change of heart, Rooster and Lily get arrested, and Annie is adopted by Daddy Warbucks.
That song popped into my head this morning as I was thinking about how uneasy many of us are feeling about the market’s persistent climb even in the face of risks that include slowing economic data, tariff fallout and geopolitical tensions.
The latter is in the spotlight today as President Trump flies to Anchorage, Alaska, to meet with Russian President Vladimir Putin for discussions about Ukraine. Notably, that conversation will not include Ukrainian President Volodymyr Zelensky, a sideline that is troubling especially when early previews of the conversations have mentioned land swaps in exchange for peace that, at the outset, are terms not acceptable to Ukraine and not in Trump’s purview to negotiate.
Turning to this week’s economic and market data, headline July retail sales growth at 0.5% was down from June, but June retail sales were revised higher to 0.9% from 0.6%. Sales were strong across the board, with the largest jumps in motor vehicle and parts dealers, as well as in furniture and home furnishing stores.
Unfortunately, a report from the University of Michigan on consumer sentiment was not so rosy. Sentiment declined on inflation worries as consumers expressed they will be buckling up for higher prices and a slowing economic environment, showing how this year’s on-again-off-again-on-again tariffs are impacting consumer psyches.
While financial markets largely shrugged off the July inflation reports, it is good to review the data. The headline consumer price index (CPI) rose 2.7% on an annual basis, matching the annual gain in June, as lower energy prices helped suppress the increase in headline prices. Excluding food and energy prices, however, core CPI climbed 3.1% year over year, marking the largest annual increase since February.
The acceleration in inflation reflects a rise in services costs as well as evidence that some tariffs are filtering into the economy. Prices for goods like furniture, apparel and toys continued to rise at the start of the third quarter; this suggests that many businesses were initially able to mitigate the impact of higher prices on the consumer by stockpiling inventories or even reducing profit margins. But, at this point, the willingness to shield the consumer is dissipating, as we saw in the data that businesses are passing on at least a portion of the cost increase to the consumer.
Meanwhile, the producer price index (PPI) rose 0.9% in July, the largest monthly gain in three years. Year over year, producer prices rose 3.3% in July, up from the 2.4% annual increase in June and marking the largest annual increase since February. The hotter-than-expected PPI report was largely the result of a 1.1% rise in services costs in July, marking the largest monthly gain since March 2022. Transportation and warehousing costs rose 1.0%, and trade costs jumped 2.0% at the start of the third quarter. Additionally, machinery and equipment wholesaling rose 3.8%.
These prints are a dilemma for the Federal Reserve, as calls grow even louder for the central bank to cut interest rates. But with jobs growth averaging less than 40,000 over the last three months, it might be just too hard not to succumb to the pressure to reduce interest rates.
However, if and when they do, it is not a necessary outcome that markets will rise or feel relief. It could cause investors to pause and consider if the Fed is more worried about growth than they have projected to the world and set up some challenging stagflation scenario comparisons. I would also reiterate that the uneasy street we are all walking is exacerbated by the fact that markets are priced for perfection, so there is not much cushion in valuations to contemplate some of these risks.
But—and here comes some positive thinking—with more than 90% of firms reporting, the blended S&P 500 earnings per share growth rate is now 13.2% for the second quarter up from the expected 5.8% at the start of July. That is pretty darn spectacular, especially given the operating environment CEOs have had to manage through.
Knowing that, perhaps we need to worry less about “villains” interrupting the happy ending with some plot or scheme and focus instead on all the good being done by the businesses owned in your portfolios. While not perfect, they have done a very good job managing through pandemics, politics and rising prices overall, and are not dire in their outlooks; in fact, most are providing balanced assessments of the risks of tariffs and the opportunities of AI for their businesses.
With that, let’s focus on how to make our walk forward into year end less uneasy, and give you confidence we are balancing all these factors into your personal plan.
Written by a human.