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.   

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.

by Jonathan Susser, Investment Technology Associate

Overview

• Global pressures continue to weigh on the markets, leading to a poor week for US equities and fixed income. Inflation remains a concern as agricultural commodities and oil appreciate in price, hurting consumers’ wallets at the grocery store and gas pump. The Russo-Ukrainian war continues to be a major point of global focus as Western aid is distributed to Ukraine.

Markets (as of April 29th; change since April 25th)

US Economy

• The 1Q22 earnings season continues—of the 266 companies in the S&P 500 to report so far, about 66% have beaten revenue estimates and 81% have exceeded profit expectations. For the S&P 500 overall, year-over-year sales growth is projected to be roughly 11.1% and earnings to rise approximately 0.6%, according to Bloomberg.
• In March, personal income rose 0.5% over February, lower than the revised 0.7% estimate. Personal spending nearly doubled estimates of 0.6% growth at 1.1%. Savings declined month-over-month to 6.2% versus the revised 6.8% figure seen in February. Chart 1 below showcases income versus spending rates on a year-to-year basis.

Chart 1: Personal Income versus Spending Rates Year-over-Year

• The PCE Deflator rose 0.9% month-over-month, meeting projections. This compares to February’s revised 0.5% increase. On a year-over-year basis, the PCE Deflator rose 6.6%, slightly below the 6.7% expected and higher than February’s 6.3% increase. The PCE Core Price Index rose 0.3% from February, and 5.2% higher than last year, slightly lower than 5.3% expectations, as seen in Chart 2.

Chart 2: PCE Core Inflation Year-over-Year

Policy and Politics

• President Biden requested $33 billion in both economic and military aid for Ukraine, causing the Kremlin to reframe the conflict as a war against the West and threaten retaliation. The Russian Defense Ministry claims that 1,351 soldiers have been lost to Ukraine, while UK intelligence claims that number to be north of 15,000.
• China’s “Zero-COVID” lockdowns continue as roughly 180 million people across 27 cities remain stuck in their homes with no end in sight. In Beijing and Shanghai alone, this accounts for roughly 7.25% of China’s overall GDP.

What to Watch

• The Federal Reserve is expected to raise rates by 50bps at the FOMC meeting on May 4^th.
• US Nonfarm Payrolls data will be released on Friday, May 6^th, with estimates at 380k.
• US Unemployment Rate data will be released on Friday, May 6^th, with forecasts around 3.5%.

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.   

by William Henderson, Chief Investment Officer
Major U.S. stock market indexes gave back some of their March gains as inflation pressures persisted, the Russia / Ukraine war dragged on and comments from the Fed about balance sheet reduction weighed on investors’ concerns. Conversely, pockets of good news persisted, oil prices, for example, again fell further and strength in the labor markets continued. For the week ending April 8, 2022, the Dow Jones Industrial Average fell -0.3%, the S&P 500 Index fell -1.3% and the NASDAQ, an index representing growth stocks which are more sensitive to higher interest rates, fell by -3.9%. Overall weakness in the equity market continues and year–to-date returns remain solidly negative. Year-to-date, the Dow Jones Industrial Average is down -3.9%, the S&P 500 Index is down -5.5% and the NASDAQ is down -12.2%. News from the Fed about continued rate hikes and balance sheet reduction weighed on bond markets and the 10-Year U.S. Treasury bond rose an additional 37 basis points to 2.76%. After starting the year yielding 1.51%, the 10-Year Treasury is up a stunning 125 basis points so far in 2022 and at its highest level since March 2019. (See the chart below from Valley National Financial Advisors and YCharts showing the 10-year U.S. Treasury rate).   

While trying not to seem repetitive, the underlying fundamental strength of the U.S. economy (labor markets, consumer heath, bank balance sheets, corporate earnings) does not seem to counter the headwinds of higher inflation and higher interest rates. This week we will get some additional information around inflation as the monthly and yearly U.S. Consumer Price Index change for March 2022 is released on Wednesday. The previous YoY (Year Over Year) reading was +7.87% and a level at or higher will certainly give the Fed all the air cover it needs to aggressively raise interest rates further. Friday begins the release of First Quarter earnings and banks will be first to report. Expectations for the first quarter are low compared with previous quarters. According to FactSet, analysts surveyed expect EPS (Earnings Per Share) increases of S&P 500 companies to average only +4.5%; which would be the first time in two years that earnings growth did not top +10%.

Turning to the Russia / Ukraine war and market implications, there was a small piece of information that may help explain why the massive move upward in the Russian Ruble. China and Russia announced commodities trading between the two countries using a Yuan / Ruble currency conversion trade. Traditionally, commodities such as oil, that trade on international markets must be traded in U.S. Dollars only. Information around the China / Russia trade has helped to buoy the Ruble bringing the level back to pre-invasion levels. (See the chart below from Bloomberg).   

Trading outside of the U.S. Dollar has allowed the Ruble to rebound and shows how countries outside of NATO, China in this case, are helping Russia deal with crippling economic sanctions imposed by Western nations. Sadly, this gives us no reason to expect the Russia / Ukraine war to end anytime soon. 

Next week (April 18) brings the due date for Americans to file their 2021 tax returns. Most Americans are expecting refunds on their tax filings. A piece by Goldman Sachs noted that expectations are for refunds to exceed recent years due to the expanded tax credit and other fiscal transfers (See the chart below from the Department of the Treasury and Goldman Sachs).

Additional cash into consumers’ pockets over the coming few weeks will pile onto the cash they have already accumulated over the pandemic from increased savings, reduced spending, and government stimulus payments. In the face of rising costs of many consumer goods and services, this additional cash will give consumers a needed cash cushion. Lastly, remember that more than 60% of the U.S. economy is consumer driven and a healthy consumer flush with cash and employed always leads to continued economic growth. 

by William Henderson, Chief Investment Officer
Volatility and uncertainty are the best two words to succinctly describe the first quarter of 2022 and, as we have always said, both of those are bad for markets. Markets like boring and we did not get a lot of boring in the first quarter of 2022. Instead, we had continuing high inflation data, Russia starting a war with Ukraine, and the first Fed rate hike since December 2018. Over the course of the quarter, we saw violent swings in the stock market and huge intra-day moves in prices, which were largely attributed to uncertainty around the Russia/Ukraine war. War in that region severely impacted prices for certain commodities and strained an already stressed market still suffering from global supply chain issues due to the pandemic. Ukraine and Russia are large producers of oil, natural gas, wheat, and certain rare early elements such as palladium which is used to make catalytic converters for cars and trucks. Additional shortages in these critical commodities immediately spiked higher prices across the board and sent overall inflation numbers higher. 

Quarter-end returns do not accurately reflect the markets’ violent swings during the quarter. Looking at the chart below from Valley National Financial Advisors and YCharts, we see the quarter-end numbers for each major market index.   

While the chart shows the NASDAQ at -9.1% for the quarter-end March 31, 2022, at the bottom of the quarter, the NASDAQ was down over -20%. The chart reflects the huge move upward during the month of March as the risk-off trade faded and investors moved again to buy equities. For the quarter-end March 31, 2022, the Dow Jones Industrial Average fell -4.75%, the S&P 500 Index fell -4.95% and the NASDAQ fell -9.10%. Fixed income investors fared no better as the Barclays Bloomberg U.S. Aggregate Bond Index (a widely used measure of fixed income investment performance) fell -6.12% in the first quarter. The benchmark 10-Year U.S. Treasury bond started the year at 1.52% and ended the quarter 80 basis point higher at 2.32%. 

Around mid-March, the markets forged a dramatic turnaround as investors believed equities fell enough now warranting buying again. In our opinion, the markets were simply focusing on the strength and solid fundamentals underlying the U.S. economy: corporate profitability, bank health, the strong labor market, and consumers’ overall financial health. While these factors alone were not enough cure all the world’s ailments, specifically the Russia/Ukraine war, they were enough to pull investors back to U.S. equities. 

Corporate profitability, while slowing a bit so far this year, hit a record in 2021, and is expected to continue its upward trend in 2022. For the full year 2021, pre-tax profits rose 25% to roughly $2.81 trillion, which more than outpaced the 7% rise in consumer prices over the same stretch; proving that companies were able to pass on to their customers much of the underlying spike in materials and labor costs.  (See the chart below from the U.S. Commerce Department showing U.S. pre-tax corporate profits 2007-2021.)   

The labor market continues to be strong with new jobs being created each month. The unemployment rate fell to 3.6% in March from 3.8% a month earlier, quickly approaching the February 2020 pre-pandemic rate of 3.5%, a 50-year low. While low, the jobless rate helps to boost wages, higher inflation continues to impact workers pockets as prices for basic goods like gasoline and food creep higher each month. (See the chart below from the Federal Reserve Bank of St. Louis showing the unemployment rate since 1950). 

As mentioned, corporate profitability shows that companies have been able to pass on inflationary prices of materials to the consumer. Further, more people are working as evidenced by the unemployment rate. Certainly, these two factors coupled with global supply chain issues and commodity shortages exacerbated by the Russia/Ukraine war have impact inflation beyond the Fed’s 2.5% target rate. Hence, Fed Chairman Jay Powell’s response by raising interest rates at the March 2022 FOMC meeting. Given where inflation and employment levels are, we expect, along with all Wall Street economists, more rate hikes to follow in 2022. For a visual of how dramatic the inflation spike is, see the chart below from the Federal Reserve Bank of St. Louis showing the Median Consumer Price Index (common gauge of inflation) 1985-March 2022.   

There’s an old Wall Street maxim that states: “higher prices cure higher prices.” Essentially, stating that as prices increase, fewer buyers will emerge and thereby decreasing demand and high prices. In the current case, we have very healthy consumers with a lot of cash in their coffers accumulated over the past two years as spending on leisure activities was practically halted yet cash continued to build up from savings and government stimulus funds widely distributed to Americans. M2 – the measure of the total U.S. Money Supply stands at a record $21.8 Trillion, giving consumers a lot of cash to spend – eventually. (See the chart below from Valley National Financial Advisors and YCharts showing M2). 

“Eventually” is the key word here. The second quarter of 2022 brings Spring and the widespread lifting of pandemic-related lockdowns. With the grand reopening of the U.S. economy, consumers will be released to spend and enjoy travel, leisure, and other expensive activities – all at the newest, latest, and greatest “higher prices.” “High prices cure high prices.” 

While the pandemic in the United States seems well behind us, other parts of the world are still suffering its devastating effects. For example, China continues to impart severe lockdowns on whole regions in an attempt to quell the spread of COVID-19. Further, the Russia/Ukraine war is far from over resulting in continued disruptions in key commodities such as oil and wheat, which are dramatically impacting prices in the EU region and beyond. The U.S. is not immune to the pandemic or inflation and the Fed continues to watch both reminding us along with way that their dual mandate of full employment and 2.5% annual inflation are front and center for Powell. While the first quarter of 2022 produced negative returns for stocks and bonds (a very rare event), we remain positive on the economy and the markets for the remainder of the year with a word of caution for investors. Volatility will be present based on continuing unrest due to geopolitical events and continued pressure due to inflation, which will certainly shape the direction and severity of interest rate hikes by the Fed. 

by William Henderson, Chief Investment Officer
There was considerable volatility in the stock market last week, much like we have seen thus far in all of 2022. However, each major market index managed to chalk up a gain for the week. The Dow Jones Industrial Average posted a meager +0.3%, the S&P 500 Index rose +1.8% and the NASDAQ moved higher by +2.0%. Trends are always risky to call here, but that gives us two weeks in a row of positive returns on the markets and certainly a little bit closer to positive returns for the year. Year-to-date, the Dow Jones Industrial Average is down -3.6%, the S&P 500 Index is down -4.4% and the NASDAQ, which represents growth stocks is down -9.3% in 2022. While stock market returns were positive, the bond market handed investors a bad week with the 10-Year U.S. Treasury rising 34 basis points to 2.48% from 2.14% the week before, the highest level since September 2019. Bond yields are reflecting two key points in the markets: 1) The Fed’s new tightening regime, which began when the FOMC (Federal Open Market Committee) raised interest rates by 25 basis points and further pointedly stated up to six more rate hikes will follow; and 2) Persistent inflation that is running at 40-year highs.

During the press conference after the FOMC announcement about the rate hike, Fed Chairman Jay Powell was certainly bullish on the economy, stating clearly, “the American economy is very strong and well positioned to handle tighter monetary policy.” The Fed is using their toolkit to quell runaway inflation with the expectation that higher short-term rates will not slow the economy. Shorter-term bond yields are already reflecting a lot of the expected Fed tightening yet to come. Two-Year U.S. Treasury yields are up 75 basis points in March and have risen 162 basis point in 2022 to 2.35% currently. Economists like to measure the so called “10s-2s spread,” meaning the spread in yield between 10-Year rates and 2-Year rates. Often, but not always, this measure has been used to predict a slowdown in the economy. (See the chart below from Valley National Financial Advisors and YCharts showing 10s-2s spread over the past year.) 

While not yet negative, the spread has come down drastically over the past year and is now nearly flat – meaning you get extraordinarily little additional yield when buying a 10-Year U.S. Treasury (2.48%) compared to a 2-Year U.S Treasury (2.35%). This curve has flattened a lot this year reflecting the tighter monetary policy of the Fed and softer economic growth expectations for 2022 and 2023. This move in rates is in sharp contrast with Chairman Powell’s comments around strong expectations of U.S. economic growth and could simply be that the 2-Year U.S. Treasury has already priced in most future rate hikes. 

It is important to understand that while interest rates are rising, they are not yet restrictive. Borrowing rates such as bank loans and mortgage rates remain low, offering borrowers attractive levels when expanding businesses or buying houses, confirming there is sufficient strength for consumers and businesses to absorb higher rates. Certainly, the strength of the labor market alone gives us confidence in the economy. Job openings remain high, unemployment remains at record lows and consumer confidence while falling a bit is still solid, especially given the $2 trillion in excess accumulated savings behind American households. Finally, we have pointed out here previously that stock markets have shown positive performance in 11 of the 12 previous rate hike cycles; again, showing that rising interest rates, especially from all time low levels, do not spell disaster for the economy. 

As mentioned above, mortgage rates are increasing along with all interest rates but, by historical measures, mortgage rates remain low and still offer future and existing homeowners attractive borrowing levels. (See the chart below from FactSet showing 30-year mortgage rates over the past 50 years).  

Higher mortgage rates will not completely cool the hot housing market, but they could quell the strong increases in home prices we have seen over the couple of years. This act alone will help cool overall inflation levels and assist the Fed in that goal. Housing continues to be a strong component of the economy and leading housing indicators such as new home sale surveys and building permits remain elevated. 

We remain cautiously optimistic on the stock market and the economy, for the reasons suggested above. The Russia/Ukraine war drags on with little mention of real cessation of aggression by Russia. The war continues to impact the energy markets specifically supplies of natural gas and oil to European Union regions, and some odd commodities such as palladium. Overall, the markets are dragging on and anticipating the end. There is sufficient expected growth in corporate earnings in 2022, which alone will be a source of decent returns in the equity markets. Lastly, bonds in 2022 have performed poorly, but now with the 10-Year Treasury bond yield nearing 2.50%, perhaps the yield alone is attractive to investors. Certainly, bonds always offer portfolios protection during times drastic market uncertainty and volatility, specifically geopolitical risks and economic anxiety.   

by William Henderson, Chief Investment Officer
In much the same way we have seen violent selloffs precipitated by a risk-off trade, last week we saw a massive rally in equities and a related risk-on trade across all equity market sectors. The major market indexes posted their largest weekly gains since November 2020. The Dow Jones Industrial Average rose +5.5%, the S&P 500 Index rose +6.2% and the NASDAQ jumped higher by +8.2%. We have often spoken about the pitfalls of market timing and risks of missing the “big-move” days, well last week was a big-move week that rewarded investors that stayed the course and remained committed to their long-term investment plan. Year-to-date returns, while still in negative territory for the year, gained back a lot of their losses thus far in 2022. Year-to-date, the Dow Jones Industrial Average is down -3.9%, the S&P 500 Index is down -6.1% and the NASDAQ, gaining back over half of its year-to-date loss is now down -11.1% in 2022.  

In potentially the least anticipated move of the year, the FOMC (Federal Open Market Committee) raised interest rates by a quarter of a point for the first time since 2018. Further, Fed Chair, Jay Powell, projected a clear path for 2022 with as many as six additional rate hikes bringing short-term rates to 1.75-2.00% by year-end 2022. Amid this news and continued high inflation readings, prices of government bonds fell, sending yields on U.S. Treasury Bonds higher for the second week in a row. The yield on the benchmark 10-Year U.S. Treasury Bond rose to 2.14% on Friday – the highest level in three years and up sharply from 1.73% just two weeks ago when the Ukraine / Russia war forced a temporary flight to quality amid major global geopolitical uncertainty. (See the chart below from the Federal Reserve Bank of St. Louis showing the 10-Year U.S. Treasury over the past three years.) 

Despite the continued geopolitical uncertainty, inflation in the U.S. is clearly the dominant story and the absolute focus of the Fed. Chairman Powell is intent on raising rates this year to combat the strongest inflation data in 40 years. Price pressures exist on many fronts beyond those impacted by the pandemic and the resultant supply-chain crunch. Higher prices are being seen in autos, food, housing, rents, and many critical commodities such as oil and nickel, which are further pressured due to economic sanctions on Russia. During Powell’s press conference, after the FOMC meeting, he mentioned that Fed policymakers are now projecting inflation (as measured by core Personal Consumption Expenditure or PCE) to reach 4.1%, up from their previous projection of 2.7%. Policymakers are clearly acknowledging that inflation will remain elevated for an extended period, and they are intent on gradually raising rates to combat inflated prices. While interest rate hikes are on the horizon for 2022 and into 2023, it does not mean that equities will perform poorly.  In fact, over previous rate hiking cycles, equities markets have performed quite well. (See the chart below from FactSet and Edward Jones showing previous rate hike cycles and returns of the S&P 500 Index.) 

When you review the fundamentals of the U.S. economy and by extension the equity markets, the foundation for strength in both continues. In fact, most major components of the economy: housing, bank health, corporate strength, consumer health and labor remain solid. Chairman Powell pointed to the extraordinarily strong economy and tight labor conditions as additional reasons why they were raising rates at this time. Pointedly, unemployment is at a near record low 3.8%, while job openings continue to exceed the number of unemployed leaving a very tight labor market as a result. (See the chart below from FactSet showing the gap between job openings and the unemployed). The widening gap shown is evidence of tight labor conditions. 

It is difficult, if not impossible, to project market returns weeks ahead, let alone months and years. The geopolitical concerns remain economic headwinds specifically the Russia / Ukraine war and price pressures in critical commodities like oil and rare earth metals and, as we have mentioned multiple times, markets hate uncertainty. The road ahead will be choppy and uncertain, and the Fed is attempting the oft impossible “economic soft-landing” of raising interest rates to stifle inflation, but not bringing the economy to a halt. As witnessed by last week’s stellar rally in equity markets, hiding on the sidelines is not a winning strategy.