As we move into the second half of 2022, there are lots of things to worry about. Covid-19 is still spreading, here in the U.S. and worldwide. Inflation is close to 40-year highs, with the Fed tightening monetary policy to fight it. The war in Ukraine continues, threatening to turn into a long-term frozen conflict. And here in the U.S., the midterm elections loom. Looking at the headlines, you might expect the economy to be in rough shape.
But when you look at the economic data? The news is largely good. Job growth continues to be strong, and the labor market remains very tight. Despite an erosion of confidence driven by high inflation and gas prices, consumers are still shopping. Businesses, driven by consumer demand and the labor shortage, continue to hire as much as they can (and to invest when they can’t). In other words, the economy remains not only healthy but also strong—despite what the headlines might say.
Still, markets are reflecting the headlines more than the economy, as they tend to do in the short term. They’re down substantially from the start of the year but showing signs of stabilization. A growing economy tends to support markets, and that may be finally kicking in.
With so much in flux, what’s the outlook for the rest of the year? To help answer that question, we need to start with the fundamentals.
The Economy
Growth drivers. Given its current momentum, the economy should keep growing through the rest of the year. Job growth has been strong. And with the high number of vacancies, that will continue through year-end. At the current job growth rate of about 400,000 per month, and with 11.5 million jobs unfilled, we can keep growing at current rates and still end the year with more open jobs than at any point before the pandemic. This is the key to the rest of the year.
When jobs grow, confidence and spending stay high. Confidence is down from the peak, but it is still above the levels of the mid-2010s and above the levels of 2007. With people working and feeling good, the consumer will keep the economy moving through 2022. For businesses to keep serving those customers, they need to hire (which they are having a tough time doing) and invest in new equipment. This is the second driver that will keep us growing through the rest of the year.
The risks. There are two areas of concern here: the end of federal stimulus programs and the tightening of monetary policy. Federal spending has been a tailwind for the past couple of years, but it is now a headwind. This will slow growth, but most of that stimulus has been replaced by wage income, so the damage will be limited. For monetary policy, future damage is also likely to be limited as most rate increases have already been fully priced in. Here, the damage is real, but it has largely been done.
Another thing to watch is net trade. In the first quarter, for example, the national economy shrank due to a sharp pullback in trade, with exports up by much less than imports. But here as well, much of the damage has already been done. Data so far this quarter shows the terms of net trade have improved substantially and that net trade should add to growth in the second quarter.
So, as we move into the second half of the year, the foundation of the economy—consumers and businesses—is solid. The weak areas are not as weak as the headlines would suggest, and much of the damage may have already passed. While we have seen some slowing, slow growth is still growth. This is a much better place than the headlines would suggest, and it provides a solid foundation through the end of the year.
The Markets
It has been a terrible start to the year for the financial markets. But will a slowing but growing economy be enough to prevent more damage ahead? That depends on why we saw the declines we did. There are two possibilities.
Earnings. First, the market could have declined as expected earnings dropped. That is not the case, however, as earnings are still expected to grow at a healthy rate through 2023. As discussed above, the economy should support that. This is not an earnings-related decline. As such, it has to be related to valuations.