This past quarter was a great reminder of why we stay invested in various markets even when uncertainty is high. No one has the crystal ball to say exactly when things may turn on a dime.
The US-Iran war caused the Strait of Hormuz to close to oil traffic resulting in elevated energy prices, a falling stock market, and huge uncertainty across the globe. As we sit today, the parties have come to a 60-day cease-fire agreement in which they plan to hold further discussions about the future of Iran’s nuclear program. Even before the final 60-day agreement was reached, we saw the stock market broadly recover, and once the deal was reached we’ve seen oil start to come back down in price. Some of this was the result of peoples’ worst fears about the war not being realized.
The other part was a story of US economic resilience and an extraordinary earnings season for stocks. This was an example where the primary narrative about the market was overtaken by hard data and company results. According to Interactive Investor, S&P500 companies saw earnings growth of approximately 28% year-over-year in Q1!
We also saw a rebound in the labor market during the past quarter with headline job growth exceeding 100k in each month since February. The unemployment rate has held steady, and consumer spending has continued to see growth even with elevated energy prices. We’ve also seen the manufacturing sector continue to grow with the overall ISM Manufacturing survey in expansion for 5 months straight (first time since 2022).
All of this brings even more focus to changes at the Federal Reserve, where Chairman Kevin Warsh was sworn in to replace Jerome Powell. Any Fed chairman would be under the microscope during these times, but with new leadership, comes even more questions about the future direction of the Fed and its interest rate policy.
Chairman Warsh has publicly supported a change in direction for the Fed and how it manages monetary policy. He has stated he would like to see less official communication, a smaller balance sheet, and changes to how it views and analyzes data, particularly around inflation.
The inflation question will be particularly relevant as the Fed decides whether to raise or lower interest rates in the future. Short term inflation readings are elevated due to higher energy costs resulting from the US-Iran war. However, if the ceasefire proves durable, then we believe those readings will be short lived, and expect overall inflation to start moving back towards the Fed’s 2% target. In other words, we don’t believe the oil supply shock supports inflation more broadly, which results from too much money chasing too few goods.
The robust job market of the past few months, along with strong corporate earnings, and continued consumer spending growth speak to an economy that does not necessarily need the support of lower interest rates. Outside of interest rate sensitive sectors, such as real estate, the current level of interest rates does not appear to us to be restrictive.
Based on this analysis, we believe the Fed will be in a wait-and-see mode for the foreseeable future. We don’t expect any change of the Fed rate until the end of the year, at earliest.
A lot can change over the coming months as negotiations between the US and Iran progress. However, it appears clear that the Trump administration did not want to escalate further with Iran given the economic fallout and midterm elections approaching. That doesn’t rule out further hostilities, but watch for the cease-fire to be extended without progress in the talks, perhaps until after the elections. We may see one more larger piece of legislation this year via reconciliation, but otherwise, we expect attention to turn to the midterms and what type of government we’ll have for the next couple of years.
In the face of uncertainty, we want to stay diversified, stay invested.
Federal Reserve Policy. Chairman Kevin Warsh was sworn in and held his first meeting as Fed Chairman. The Fed left its key interest rate benchmark unchanged at 3.50-3.75% in June. While the Fed has had an unusually high amount of dissent recently, this decision was unanimous. Chairman Warsh has also expressed a desire to see the Fed change the way it does various aspects of its job, and with that, has announced the creation of 5 task forces to advise on changes by the end of this year.
Economic Growth – GDP. Q1 GDP growth rebounded from 0.5% in Q4, to 1.6% in Q1 on the second estimate. Q2 growth is estimated by Atlanta Fed to be even higher. Even with the geopolitical environment, we’re seeing the US economy power forward and seemingly gain steam throughout the first 6 months of the year.
Labor Markets. The jobs picture has markedly improved over the past 3 months with headline job creation exceeding 100k each month March-May. The unemployment rate has held steady at 4.3%. Job openings have slightly increased as well, sitting at 7.6 million in the most recent JOLTs report.
Inflation. The US-Iran war and its effects on the price of oil have sent inflation readings in the wrong direction. CPI went from a low of 2.4% early this year, to 4.2% in May. Core readings are more muted, but this nonetheless puts the Fed further away from their target. So far this is related to an oil supply shock rather than broader inflationary pressures.
Consumer Sentiment & Spending. Consumers have continued to spend this year with retails sales growing 6.9% year-over-year in May. This comes on the back of higher gas and energy costs. Consumers are benefiting from larger tax refunds due to changes in tax law passed last year. However, the longer energy prices remain elevated, the harder it will be for consumers to maintain.
Housing & Real Estate. Housing market activity has been relatively slow. Many hoped to see lower interest rates by now, which have not materialized. We’ve seen home price growth slow to a crawl based on some readings like Case-Shiller index. There is quite the drag from people being used to lower rates, but at some point the market will adjust as people run into the need to move.
Business Investment & Manufacturing. The manufacturing sector has built on early momentum this year and we now have five consecutive months of expansion according to the ISM survey, with the most recent May reading of 54.0. Inside the survey, order backlogs began growing again this year (after shrinking for 3 straight years). While this is overall positive news, we have yet to see that translate into actual employment growth in the manufacturing sector. This will continue to be a challenge going forward as factories continue to automate.
Regulatory Environment. The FDA now has new leadership, and the expectation is that the FDA will start approving medications more generally and at a quicker pace. Prior leadership was criticized for certain decisions around drug approvals, both the slow pace and the moving of goalposts. The change in leadership is expected to squarely address these items. Additionally, the Federal Reserve will continue to update its regulatory framework under its new leadership, and we’ll be keeping an eye on any changes on that front.
Global Economy. The US-Iran war continues to dominate the global environment. A 60-day ceasefire was announced and took effect on June 22nd. The Strait of Hormuz is supposed to open to traffic under the agreement. EU moves to update rules to combat heavily subsidized foreign products (primarily from China).