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.   

by William Henderson, Chief Investment Officer
Uncertainty and fear stoked market volatility last week, even a much expected 50-basis point rate hike did little to quell concerns that the Fed was behind the inflation problem in the United States.

Markets (as of May 6, 2022; 1 week Returns, Year-to-date Returns)

The markets continued to exhibit extreme volatility and last week we saw the biggest one-day gain in the Dow Jones Industrial average (+932 points on May 4) and the biggest one-day loss (-1034 on May 5). Market volatility is telling us that the struggle between higher prices (inflation) and economic growth exhibited by consumer health and the strong labor market continues. We are still confident that the Fed will be able to execute the perfect “soft landing” by gradually raising interest rates to combat inflation but not simultaneously slowing the economy so much that we fall into a recession. This may not be very comforting given the painful returns thus far in 2022 for both equities and bonds, but the premise lies firmly upon the strength of the labor markets and the relative financial health of the consumer.

It is tough to find positives to discuss when the markets are punishing investors, but we have been here before; and, as we had said over and over, pullbacks and selloffs in the market are common and to be expected. (See the chart below from Valley National Financial Advisors and Clearnomics on pullbacks). Even in years when the markets had large positive gains, intra-year there were large negative returns. The point is that timing the market is dangerous and rarely successful. 

See the chart below, from Valley National Financial Advisors and Clearnomics showing the poor result of “market timing” vs staying invested for the long term and sticking with your investment plan.

What we are focused on is the labor markets and the health of the consumer. Last week saw strong labor numbers released with 428,000 new jobs created in the month of April, unemployment staying at 3.6% and job openings listed at 11.5 million. With only 5.9 million people currently unemployed, there are two job openings for every unemployed person. While these numbers point to a booming economy, hiring new workers is not cheap and employers only hire when current staff can no longer keep up with demand. Importantly, labor demand, just like demand for goods and services, is causing inflation across the board; and continued issues with labor shortages and supply chain problems will continue to put upward pressure on prices. Remember – high prices cure high prices. Thankfully, the Fed is focused on inflation and higher interest rates will be the result of their focus. If 2.50-2.75% is the Fed’s terminal rate for Fed Funds, we may have most of that priced into the market already – the yield on the two-year Treasury note is 2.72%.

Along with near record low unemployment, consumers have record amounts of cash on the sidelines as exhibited by Household Net Worth and are sitting with extremely low Household Debt Service (see charts below from Valley National Financial Advisors and Clearnomics).

As strong as this data is, it is still not very comforting when the fixed income and equity markets are both off double digits year-to-date. As investors, we have time and history on our side and understand that market corrections occur and are healthy but never fun while happening. Bond yields at 2.72% for the two-year Treasury and 3.12% for the 10-year Treasury are attractive levels for pension funds, and foreign investors and equities are now trading at levels that again make them attractive to buyers. Caution as much patience is required at times like this, and time is always our friend and the great healer of poor market returns. Stay focused on your long-term plan and reach out to your financial advisor for guidance.