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Midyear market outlook: 3 factors experts say could affect your portfolio over the second half of 2022

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Key Points
  • The S&P 500 ended the first six months of the year down 20.6% — the worst first-half decline since 1970.
  • "Higher energy and food prices are, in effect, a tax on the consumer, who are the main engine of global economic growth," note analysts at T. Rowe Price.

When it comes to the performance of the market and more broadly, the economy, during the first half of this year, economists and market-watchers are in agreement: Not great.

The S&P 500 ended the first six months of the year down 20.6% — the worst first-half decline since 1970. The dip came as costs for goods and services ballooned, weighing on Americans' cost of living. U.S. inflation, as measured by the Consumer Price Index, came in 8.6% higher in May from a year earlier — the fastest bump since 1981.

In an effort to cool down those rising prices, the Federal Reserve has taken measures to slow the economy by raising interest rates, making it costlier for businesses and consumers to borrow money.

It's a precarious strategy, one that many economists suggest may slow the economy to the point that it tips into a recession, generally identified as a decline in gross domestic product for two straight quarters (U.S. GDP declined by 1.5% in the first quarter of 2022).

Ask the experts what comes next, and you'll get a wide variety of responses. While some see light at the end of the tunnel in the form of a market recovery, others see recession, further market turmoil, and the proverbial oncoming train.

Here are the three factors the pros say they're looking at when dissecting what may be in store for investors for the rest of the year.

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Inflation is a three-pronged threat

Rising prices present a three-pronged threat to economic and market growth, note analysts at T. Rowe Price. For one, "higher energy and food prices are, in effect, a tax on the consumer, who are the main engine of global economic growth." Two, rising prices costs can also cut into corporate profit margins. And three, if it remains high, inflation could provoke an overly aggressive Fed to raise rates to the point of causing a recession.

Some investors, the folks at T. Rowe say, believe there are signs that inflation may have already peaked, such as a slowdown in the growth of housing prices. Analysts at HSBC believe the economy is at or close to "peak pain" on inflation, but that the numbers won't meaningfully decline until late in the year.

All in all, investors hoping for a rebound are looking for a so-called "soft landing" from the Fed, in which continued interest rate hikes tame inflation without roiling the economy. That's what analysts from JP Morgan say they expect to happen in one of the most bullish outlooks available. Given improving inflation and an easing of tensions in Europe, they believe the S&P 500 could return to new highs by year-end.

Earnings can indicate companies' take on the economy

A slowing economy will almost certainly bring a slowdown in corporate earnings, which tend to fall by 30% on average during recessions, according to investment strategists at Baird. Because growth in earnings tends to drive stock prices over the long term — and because investors are forward-looking — firms regularly release expectations for future profitability.

"We're watching [second quarter] earnings very carefully for signals from companies about how they view the health of the economy," Jason Trennert, Baird CEO, said in a recent note.

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Results are just beginning to trickle in, but no major alarms have sounded yet. Out of a total of 18 companies reporting earnings for the quarter that ended in June, 16 reported above what analysts had estimated, according to data from Refinitiv. And analysts expect S&P earnings growth of 5.6% for the second quarter followed by growth of 11.1% in the third quarter.

But those numbers can change quickly as firm's projections come in. As more data becomes available, market-watchers will have a better idea of where things are headed. "Companies see their order books every day and have a very good sense in real time of what's happening to the economy, so they should be able to sniff out strength or weakness quicker than the official data," says Trennert.

Consumer confidence drives spending

If you want to know where the U.S. economy is headed, you don't have to look much further than consumers. As of the end of March of this year, consumer spending accounted for about 68% of U.S. GDP, according to the U.S. Bureau of Economic Analysis.

But rising prices on everything from tanks of gas to cartons of eggs has consumers worried. The Conference Board's Consumer Confidence Index — a measure of how confidence consumers are about their current financial situation — sank to its lowest level since February 2021 in June.

The latest decline suggests "weaker growth in the second half of 2022 as well as growing risk of recession by year-end," Lynn Franco, Senior Director of Economic Indicators at The Conference Board, said in a statement.

But on a fundamental level, consumers may not be doing as badly as they think they are. Even with prices on the rise, "strong job and wage growth" through the first half of the year "have given workers the ability to spend," say analysts at Commonwealth Financial. "Although there are risks that job growth may slow, it's currently poised to keep going up through year-end, continuing to drive consumer confidence and spending."

The views expressed are generalized and may not be appropriate for all investors. Past performance does not guarantee future results. The information contained in this article should not be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product. Carefully consider your financial situation, including investment objective, time horizon, risk tolerance, and fees prior to making any investment decisions. No level of diversification or asset allocation can ensure profits or guarantee against losses.

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