by William Henderson, Chief Investment Officer
Global anxiety bled into U.S. markets, already skittish about higher rates and sticky inflation, and left us with an extremely poor week for equity and bond returns. For the week ending April 22, 2022, the Dow Jones Industrial Average fell -1.9%, the S&P 500 Index fell -2.8% and the NASDAQ lost -3.8%. The poor returns for the week only added to poor full year returns across all market sectors. Year-to-date, the Dow Jones Industrial Average is down -6.4%, the S&P 500 Index is down -10.0% and the NASDAQ is down -17.8%. The dispersion between the Dow Jones and the NASDAQ returns reminds us of the importance of a diversified equity portfolio that crosses all market sectors. Hawkish comments (meaning – those with inflation concerns and thereby calling for higher interest rates) from several Fed governors last week pushed bond yields higher once again and the yield on the 10-Year U.S. Treasury ended the week at 2.90%, seven basis points higher than the previous week. 

We have stated many times about the solid condition of the U.S. economy when you consider the consumer, the labor market and the health of banks and corporations. Several Wall Street prognosticators and economists are calling for a recession in either late 2023 or 2024. We are not in that camp, based solely on our long-standing view that recessions are almost always preceded by a weak housing market and poor labor conditions – neither of which are present now. The chart below from Valley National Financial Advisors and YCharts shows the 20-year unemployment rate, currently 3.6%, and the 30-year fixed mortgage rate, currently 5.00%. Both levels support the premise that the U.S. economy is in sound financial shape as employment is solid and mortgage rates remain reasonable, especially for first-time home buyers. 

Yet, the markets are falling week-after-week. The markets are not digesting the global unrest (Ukraine / Russia War), global economic concerns (EUR region could see a recession as soon as 2023) and continued worrisome news on COVID lockdowns in Shanghai and Beijing, China, which risk another global supply chain meltdown. There is an old economic axiom that states: “When the U.S. gets a cold, the world gets the flu.” We are not willing to change Wall Street or economic axioms here, but it would seem to us that the world has the flu, and we are at risk of catching a cold. Our “cold” is certainly being exacerbated by the Fed’s current aggressive strategy on raising interest rates. What is most puzzling is the reaction from the market, given the fact that the Fed has been completely transparent on its path to higher rates. Fed Chairman Jay Powell is intently focused on bringing inflation under control and closer to their 2.5% target rate and the easiest way to accomplish this is through higher rates to quell hot inflationary pressures. 

Even with higher rates on the horizon, the economy will continue to expand at an estimated 3% in 2022, which is strong by recent historical standards, and well below the 6% GDP (Gross Domestic Product) growth we saw in 2021. Markets have dealt with rising interest rates in the past and have performed quite nicely. The economy is sound, the consumer is armed with more than $2 trillion in accumulated savings and wage growth is accelerating, so consumers are not reliant on borrowing or low interest rates to fuel household consumption, which makes up 70% of GDP. Lastly, by any measure, interest rates remain historically low and are still technically fueling economic growth. (See the chart below from FactSet showing the Federal Funds Rate from 1975). 

Valley National Financial Advisors recently published a piece sourced from Clearnomics, Inc. called “In times of stress on the markets, staying with a long-term investment plan is prudent” READ IT HERE. The premise of the piece is that time is the key ingredient in investing. Financial markets are inherently volatile over days and weeks. The stock market is no better than a coin flip, rising only slightly more than 50% of the time, and down days tend to be much worse than up days. This can be frustrating to investors who expect the stock market to consistently rise and achieve its 30-year average total return of 11.5% in any given year. There have been very few instances over the span of 10 or 20 years (The Great Depression being one) where stocks have had negative returns. When you add in the long-term compounding of interest and dividends, real personal wealth is created.  

Global uncertainty will continue to persist, and markets hate uncertainty. Watch this week for earnings release data on several important tech stocks (Apple, Amazon & Alphabet (Google)) and key inflation data on Friday. The earnings information should help with the direction of the stock market and data will show if the Fed is starting to reel in inflation.  

by William Henderson, Chief Investment Officer
A holiday-shortened trading week with minimal major news or economic releases did little to quell the continued downward slide in U.S. equity and bond markets. Even news that inflation may be peaking did little to alleviate uncertainty in the markets. For the week ended April 15, 2022, the Dow Jones Industrial Average fell -0.4%, the S&P 500 Index fell -2.4% and the tech-heavy NASDAQ, fell by -3.9%. Negative returns for the week added to already weak year-to-date returns. Year-to-date, the Dow Jones Industrial Average is down -4.7%, the S&P 500 Index is down -7.5% and the NASDAQ is down -14.5%. Bonds fared no better than stocks with the yield on the 10-Year U.S. Treasury bond rising another eight basis points during the week to close at 2.83%, the highest level since April 2018. 

The bond market seems to have priced in much of the aggressive Federal Reserve Bank tightening that Chairman Jay Powell has alluded to for 2022. Further, the Two-Year U.S. Treasury has moved from 0.73% at the beginning of 2022 to its current level of 2.47%, after briefly touching a higher level of 2.52%. The move in Treasury yields across the yield curve certainly puts a 3.00% yield on the 10-Year Treasury in range before year end. With much of the rate hike expectations priced into bond yields, futures markets are also now predicting a 50-basis point rate hike at the May Fed meeting. (See the chart below from FactSet showing a 91% possibility of 50-basis point rate hike vs. just 25 basis points.) 

As mentioned, last week saw three important inflation indicators released: U.S. CPI (Consumer Price Index), U.S. Core CPI and U.S. PPI (Producer Price Index). While each came in at record-high or near-record levels, Core CPI came in below expectations, flattening its rate at the same time. The CPI (which measures prices consumers pay for goods) figure came in at 8.5% year-over-year, in line with economists’ expectations while Core CPI (which excludes food and energy costs) came in at 6.5%, below forecasts of 6.6%. Lastly, U.S. PPI, (which measures prices paid by domestic producers), came in at 11.2% year-over-year, the highest level on record. (See the chart below from Valley National Financial Advisors and YCharts).

While headline inflation remains heated, there are signs inflation may be peaking especially in two key components: energy and housing. The Russia / Ukraine crisis continues to put upward pressure on oil and other commodities, but the average price of WTI (West Texas Intermediate) crude oil was $108 in March while it has averaged $99 in April. A continued downward trend will certainly impact CPI in the coming months. We previously noted the flexibility the U.S. energy industry built into its production cycle with pumps and wells having the ability to turn on and off as energy prices fluctuate. With WTI prices near $100 a barrel, drilling and fracking become profitable again. A natural way to measure this is the rate of new drilling permits granted. (See the chart below from Axios showing new Permian Basin drilling permits approved). More permits will pump more oil into the global oil markets which are fungible but do not expect the impact on oil supplies until 2023.   

Another component of core inflation that may start to show some moderation in the coming months is shelter (homes prices and rents) which accounts for about 1/3 of all consumer spending as measured by the Core CPI component. Mortgage rates have been rising throughout the year and recently touched 5.0%. As mortgage rates rise, shelter pricing typically declines as demand falls off, but this will take some time, just as increased drilling permits will, to flow through to inflation data. The point is that lower prices for some key consumer goods and services are coming, they are just not coming tomorrow. 

April 18, 2022 was the final day to file personal income taxes (without an extension) and thus far in 2022, the Federal government has collected a record $2,121,987,000,000 in taxes from individuals and corporations–yes that is $2.2 trillion. Earnings season gets underway this week with important banks and corporations releasing first quarter earnings. Wall Street analysts are expecting increases in earnings, but those expectations have been tempered recently as increasing prices and higher interest rates are impacting the bottom line for many companies. We are going to see a protracted period of uncertainty as the markets digest higher interest rates and higher inflation; however, relief on both fronts is starting to materialize. Lastly, the consumer, which makes up more than 60% of the U.S. economy, remains financially healthy with vast savings and historically low debt burdens. These are the times for investors to really stay focused on the long-term.