by William Henderson, Chief Investment Officer
Markets continued to reel from a slew of negative news headlines including poor earnings releases from retail stalwarts Wal-Mart and Target, new cases of COVID-19 in Shanghai, and persistent inflation especially in gasoline with the national average for a gallon of gasoline hitting $4.59/gallon vs $3.04/gallon one year ago. Thankfully, U.S. equities posted a monster 614-point rally late on Friday which allowed the markets to avoid being labeled a true “Bear Market” (meaning down 20% on the S&P 500 – see returns below). 

Markets (as of May 20, 2022; 1 week Returns, Year-to-date Returns)

It is hard being a market optimist these days and we can certainly understand how investors feel given year-to-date returns on stocks and bonds are so poor. Further, you would think the world is in even worse shape than the markets are telling us if you listen to the news. A new pandemic called Monkeypox is making headlines along with baby formula shortages in the United States seem like stories ripped from a movie about the end of the world. A market prognosticator once said, “if someone wants to bet you on the end of the world, take that bet.” We are on the other side of that bet as well. Current headlines are bad and downright scary, but the underlying fundamentals of our economy remain sound. However, the issues surrounding us are real and impact consumers in ways that eventually impact the economy. Remember, our economy is 60-65% consumer driven and when the consumer slows down or stops spending the economy will be impacted in a big way.

Several Wall Street economists are calling for a recession within the next 12 months. Certainly, with the S&P 500 Index down -18% year-to-date, the markets have already priced in a 75% chance of a recession. The issue at hand is that the Fed is doing its part to combat inflation, not prevent a recession. Fed Chairman Jay Powell refuses to temper his hawkish tone and instead is committed to raising all year toward a more neutral rate of 2.25% to 2.50% (currently 0.75% to 1.00%). At that level, or even a bit higher, it is expected that inflation will begin to significantly decline. 

As mentioned, the Fed is focused on fighting inflation rather than the markets and that is a dramatic change from previous market downturns. See the chart below from Edward Jones showing the two previous downturns (2018 & 2020) and the Fed’s reaction to those market selloffs. At the point of December 2018 correction sparked by growth concerns, the Fed clearly and succinctly stated lower interest rates were ahead which helped spur a rapid market rebound. Similarly, at the March 2020 pandemic-related sell-off, the Fed came into the markets with every tool in their toolbox and markets again rebounded quickly. 

Here we are in 2022, and the Fed is on a different mission than helping the markets rebound quickly. Instead, Mr. Powell and his Fed are all about fighting inflation. That clear divergence in mission is pushing a slower market recovery than a quick snapback as witnessed in the two previous significant downturns. 

We talked above about bond and stock markets both suffering poor returns thus far in 2022. However, for the second week in a row, U.S. government bonds rallied sending the yield on the 10-Year U.S. Treasury to 2.78% down from 3.13% a couple of weeks earlier. While a long way from the 1.51% yield we saw at the beginning of the year, the move higher in Treasury Bond prices has softened the hit fixed income investors have taken thus far in 2022. It also shows there is a modest flight to quality in the markets with buyers moving once again to U.S. Treasury Bonds when markets sell-off so aggressively. 

Watch for a few important economic indicators this week including the release of the minutes from the May Federal Reserve meeting on Wednesday and the Personal Consumption Expenditures (PCE) Price Index – the Fed’s preferred gauge for tracking inflation – on Friday. We remain committed to a long-term investment philosophy and understand that sell-offs and market corrections are common in well-functioning financial markets. 

by William Henderson, Chief Investment Officer
A visible slowdown in soaring inflation did little to quell uneasiness in the markets. Consumer sentiment (confidence) fell, and we saw a modest flight to quality as U.S. Treasury Bond prices rallied during the week.  

Markets (as of May 13, 2022; 1 week Returns, Year-to-date Returns) 

U.S. Consumer Price Index (CPI) fell modestly in April to +8.3% from +8.5% in the March. Further, Core CPI (excluding food & energy) also fell to +6.2% in April from +6.5% in March. Certainly, these numbers are still well above the Fed’s +2% inflation target, we expect the recent strong inflation data to continue to abate showing that the Fed’s efforts to slow inflation and temper the economy are working. Higher interest rates along with a notable drop in the federal deficit, a record high trade deficit fueling overseas demand, and higher mortgage rates cooling the housing market, will naturally slow the economy and thereby inflation over the remainder of 2022. Slowing economic growth is not typically a good thing but with inflation running so high, it is necessary to slow the economy to combat inflation. Most economists are expecting economic growth to slow sharply in 2022 compared to 2021.  

A slowing economy will allow supply chains to improve and shortages of certain goods to ease a bit giving consumers needed relief and finally allowing visible labor shortages to moderate. These factors will gradually allow the Fed to temper its hawkish tone which in turn could add needed relief to the equity markets. Last week, even as equity markets fell again, bond markets showed signs of life with the 10-Year U.S. Treasury bond falling 19 basis points to 2.93% from previous week’s 3.12% level. This bond rally provided investors with some surely needed support given the battering the fixed-income market has endured in 2022.  

The two charts below (both from FactSet) show why we believe the equity markets will show life before year end and provide long-term investors with needed returns.  First, valuations (P/E ratios) typically decline during Fed-tightening cycles, and we are seeing that today. Declining valuations offer investors buying opportunities as prices for equities offer “sale-levels.” Second, S&P 500 earnings are above recession levels and well above pre-pandemic levels, showing that corporations are easily weathering higher prices and supply chain issues resulting in increased earnings.   

Another item giving us hope for the equity markets is the continued massive stock buybacks that we continue to see in S&P 500 companies. For the 12-month period ending March 31, 2022, companies in the S&P 500 repurchased $953 billion of their own stock, setting a record for such purchases. Stock buybacks, while often seen as short-term relief, typically result in higher equity prices as they reduce the number of shares outstanding and show that the company feels their cash is best used by reinvesting in their own shares.   

Lastly, each week we talk about long-term investing and sticking to a plan. 2022 has been a painful year for both equity and fixed income investors with both markets down precipitously year-to-date (see returns above). That said, it is worth understanding and considering previous decades of investing. The chart below from Valley National Financial Advisors shows every decade of investing since 1977 and the resultant “bear-market” pullback during the respective bull markets. Each decade had a near 20% drop in equity prices and this decade has been no different. It is times like today that time and history must be considered and sticking with your investment strategy is always the best plan.