MICHAEL J. HALLORAN, CFA | Equity Strategist of Janney Montgomery Scott
Wyncote Wealth Management Group

Highlights for this week include: 

• This week we received further confirmation of a healthy economy and resilient consumer with better- than-expected retail sales. 

• August marks the 65th consecutive month that both headline and core inflation were above the Federal Reserve’s official 2.0% target. Stubbornly high inflation combined with the strong August labor report led to the Federal Reserve raising interest rates this week for the first time in three years. 

• The Iranian conflict and higher energy prices continue to present headwinds for the market. We note below that there are important differences today compared to previous oil shocks, led by U.S. energy independence. 

Consumer Remains Resilient Supported by Record High Net Worth and a Healthy Labor Market 

We recently noted that business surveys and labor market indicators were consistent with a healthy economy. This week we received further confirmation of a healthy economy and resilient consumer with better-than- expected retail sales. August retail sales rebounded from a fall in July by rising the most in five months, increasing 1.2% for the month and up 6.0% versus a year ago. The advance was broad-based with eleven of the twelve major categories rising for the month. The gain was led by nonstore retailers, which recovered from an unfavorable comparison month in July after Amazon moved its Prime Day sales event up to June this year, posting a robust 2.6% gain in August. 

Consumers are benefiting from a healthy labor market and record-high net worth. The healthy labor market is evidenced by weekly unemployment claims, arguably the best labor market indicator. Claims remain at historically low levels (just coming in at 196,000) and in a downtrend. 

Inflation Remains Stubbornly Above the Federal Reserve’s 2.0% Target 

Consumer prices matched expectations by rising 0.4% in August, leaving the year-ago comparison unchanged at 3.4%. Core CPI, which excludes volatile food and energy, surpassed expectations and rose 0.3%, with the year ago comparison falling to 2.4%. August marks the 65th consecutive month that both headline and core inflation were above the Federal Reserve’s official 2.0% target. 

Stubbornly high inflation combined with the strong August labor report led to the Federal Reserve raising interest rates this week for the first time in three years. The Fed raised short-term interest rates by 0.25% to a range of 3.75%-4% and noted that the hike was intended to support a timelier return to the 2% inflation target. 

Housing Remains Depressed 

New home construction continued to struggle in August, lagging expectations and falling to a 1.275 million annual rate. Home construction has been on a downward trend since peaking a month after the Federal Reserve began the previous tightening cycle back in March 2022. The key issue for homebuilders is affordability, which is now being impacted by the Iranian conflict, where surging energy costs have had an upward impact on inflation and interest rates. This has resulted in 30-year mortgage rates moving roughly 0.60% higher since February to around 7.0%, double the levels that prevailed through much of 2021. In addition, high home prices, restrictive local building regulations, tighter immigration enforcement making it tough to find or replace workers, and tariffs are also contributing to a depressed housing environment. 

Thoughts on the Ongoing Iranian Conflict and Higher Energy Prices 

The Iranian conflict and higher energy prices continue to present a headwind for the market. While recent U.S. recessions, excluding the pandemic downturn, were preceded by a sharp rise in oil prices, we note there are important differences today compared to previous oil shocks. 

1) Energy intensity of the U.S. economy is much lower today. The amount of oil necessary to produce one unit of US GDP has fallen by about 70% since 1980. This is partly because the U.S. uses more natural gas and renewables in its energy mix than in the past, and because the overall energy intensity of the economy has declined. 

2) The U.S. is energy independent and is now a much more balanced economy as a result of the shale oil and gas revolution. While high oil prices are still a tax on the consumer, many industries benefit from U.S. oil and gas production, while significant wealth that was transferred to other oil-producing nations now stays in the U.S. 

3) U.S. energy exports benefit the U.S. directly in the form of higher export revenues and benefit the rest of the world because U.S. shale producers can increase production to make up for decreased production elsewhere. This is highlighted by U.S. natural gas production, which has displaced Russian gas in Europe since the invasion of Ukraine. As a result of the Iranian conflict, European and global gas prices have spiked while U.S. gas prices have seen a muted response. This is a relative benefit to U.S. consumers and businesses. 

4) We also note that the U.S. economy remains healthy, six months into the conflict. The recent business surveys, labor market reports, and corporate profits are all consistent with a healthy economy. This suggests the U.S. economy has been well-positioned to absorb the fallout from the crisis. 

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