Odds For A Soft Landing Improve

The stock market continues to defy the skeptics, rallying to new all-time highs week after week, but the rally has been extraordinarily narrow, leading to legitimate concerns about valuations in the technology sector. A price adjustment from current levels seems inevitable, which should lead to a pullback in the major market indexes, given the outsized weighting the sector has today. Still, any drawdown this summer should also lead to another investment opportunity in this bull market, as broader sector participation ensues during the second half of the year in anticipation of a soft landing for the US economy.

We had extremely encouraging news on the soft landing front with last week’s S&P Global Composite PMI report for June. The rate of growth in business activity rose to a 26-month high with the composite index rising to 54.6. This strength was led by the services sector, but the manufacturing sector has also been in expansion territory for five of the past six months. Surprisingly, this renewed strength is not leading to upward price pressures, as the survey’s gauge of selling price inflation fell, due to slower growth in input costs, which S&P Global’s Chris Williamson said, “brings the survey’s price gauge into line with the Fed’s 2% target.” This is certainly not indicative of a hard landing or a recession, as many suggest we will see over the coming year.

Despite these Goldilocks numbers, consumer sentiment fell to a seven-month low in June, which is consistent with previous levels that coincided with the economy in recession. Why the disconnect? Granted, we are starting to see some financial stress for lower-income households, as excess savings have been drawn down and delinquency rates on credit cards and auto loans have returned to pre-pandemic levels. Yet home mortgage delinquencies are near all-time lows, and household wealth is at record highs.

Furthermore, the rate of inflation has fallen nearly as fast as it rose, but I think consumers are focusing on elevated price levels more so than the declining rates of increase. At the same time, most ignore the fact that wages have been growing more than the rate of inflation over the past year, offsetting the decline in excess savings. That savings is what helped buffer the decline in real wages during the two years that followed the pandemic.

I think the sour mood also has a lot to do with the fact that it is an election year, and surveys of consumers have become increasingly polarized due to the nature of our politics. Regardless, I am more interested and focused on what consumers do than what they say, as that is what will lead to a more accurate economic forecast. Despite stress at the bottom on the income scale, collectively consumers continue to spend at a rate that should prolong the expansion.

This should also help to limit any drawdown in the stock market that may occur this summer in the process of resolving the extremely overbought condition in the technology sector. The Philadelphia Semiconductor Index was trading 35% above its 200-day moving average at its peak last week. Reconnecting with its 50-day moving average would lead to a 15% correction in price. That would be a good start to refreshing the uptrend. I expect to see new leadership during the second half of this year as we move closer to the first rate cut from the Federal Reserve no later than September, but I think another decline in the personal consumption expenditures (PCE) price index this Friday could increase the probability that we see a cut in July.

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