Daily Archives: May 17, 2022

Current Market Observations

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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.   

The Numbers & “Heat Map”

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THE NUMBERS
The Sources: Index Returns: Morningstar Workstation. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. Three, five and ten year returns are annualized. Interest Rates: Federal Reserve, Mortgage Bankers Association.

MARKET HEAT MAP
The health of the economy is a key driver of long-term returns in the stock market. Below, we assess the key economic conditions that we believe are of particular importance to investors.

US ECONOMY

CONSUMER HEALTH

NEUTRAL

 Q1 2022 Real GDP shrunk at a 1.4% annual rate according to the first advance estimate. This is the first contraction since the beginning of the pandemic. The main factors that resulted in a decrease in GDP were a surge in imports and trade deficit highlighting that the U.S. is buying more goods from foreign countries. This may be an indication that the U.S. economy has recovered faster than other countries.

CORPORATE EARNINGS

NEUTRAL

 For Q1 2022 the estimated earnings growth rate is 9.1% — the lowest since Q4 2020 (3.8%). This estimate was revised upward from the previous forecast of 7.1% in April. So far, 91% of S&P500 companies have reported earnings — 77% reported a positive EPS surprise and 74% beat revenue expectations.

EMPLOYMENT

POSITIVE

 Total nonfarm payroll employment rose by 428,000 in April compared to an estimated 398,000. The unemployment rate remained constant at 3.6%. Job growth was widespread, led by gains in leisure and hospitality, manufacturing, and transportation and warehousing.

INFLATION

NEGATIVE

 CPI rose 8.3% year-over-year in April 2022, compared to an estimated increase of 8.1%. Core CPI recorded a 6.2% increase, and PPI increased by 11%. Shelter, food, airline fares, and new vehicles were the largest contributors to the soar in CPI. The energy index fell for the first time in recent months — gasoline decreased by 6.1% while natural gas and electricity increased.

FISCAL POLICY

NEUTRAL

 After passing a $13.6 billion package to support Ukraine a few weeks ago, the House approved an additional $40 billion military and humanitarian package for Ukraine. The bill was passed with 368 votes against 57 votes. The total of the two packages ($53 billion) is the largest foreign aid moved through Congress in more than 20 years.

MONETARY POLICY

NEUTRAL

 The Fed raised rates by the expected 25 bps in March and 50 bps in May. Jay Powell projected a clear path for 2022 with as many as five additional rate hikes bringing short-term rates to 1.75- 2.00% by year end 2022. The next decisions by the Fed will be data-driven based on future inflation numbers and estimated economic growth.

GLOBAL CONSIDERATIONS

GEOPOLITICAL RISKS

NEGATIVE

 Russia was able to avoid default last week by making the required payment on its debt however, the markets are still assessing the probability of default in the coming months at 87%. This is primarily due to sanctions imposed by Western countries which are hindering the Russian economy and restricting capital flows in and out of Russia.

ECONOMIC RISKS

NEUTRAL

 Supply chain disruptions in the U.S. are waning but the rising cost of oil due to the Russian- Ukraine war is likely to cause additional inflationary pressures not only on gasoline prices but also on many other goods and services. China is targeting June to end the Shanghai Covid-19 lockdown in hopes to revive its economy.

The “Heat Map” is a subjective analysis based upon metrics that VNFA’s investment committee believes are important to financial markets and the economy. The “Heat Map” is designed for informational purposes only and is not intended for use as a basis for investment decisions.

“Your Financial Choices”

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“Your Financial Choices” on WDIY 88.1 FM will be a pre-recorded show this week – May 18. Laurie will return live on May 25 with a guest to discuss Medicare Supplemental Plans.

Laurie will address questions submitted via yourfinancialchoices.com during the next live broadcast. Recordings of past shows are available to listen or download at both yourfinancialchoices.com and wdiy.org.