Market & Economic Commentary– April 2022
April 18, 2022
By, Peter Mueller & Steve Taddie
Up the Down Staircase
Asset price volatility returned in the first quarter, marking wide intraday price swings in the major market indices. During the quarter, the S&P 500 recorded 30 days in which the index rose or fell by 1% or more. This tally is 61% higher than the average first quarter count since World War II. Volatility is often ignored on the upside as it increases portfolio values, while downside volatility feels downright awful as portfolio values decline. Investors must remember that this is a normal course in financial markets. To achieve return, one must assume risk and be able to invest through more turbulent times such as today’s climate. Only with a long-term investment horizon, can we reduce risk as it diminishes when our investment time horizon lengthens. That being said, it still does not nullify the discomfort of investing during periods such as these.
After US stock markets reached new highs in 2021, the weight of economic and geopolitical “issues” became too heavy, causing stock markets to reverse course after the first of the year. With the US stock market hitting a mid-March low, down about 12%, before finding its footing and gaining back most of its decline by quarter-end, finishing down about 5% for the quarter. In the bond market, after staying in a range of 1.75% – 2.00% for most of the quarter, the 10-year US Treasury Note’s interest rate sprinted to about 2.50% in the month of March, approaching pre-Covid (March 2020) levels before dropping off slightly at quarter end to finish at about 2.3%.
Valuation in the stock market has moderately improved due mainly to cheaper prices but also to strong corporate results in the fourth quarter of 2021 and anticipated earnings for 2022, which are estimated to be $225 per share (S&P 500). Based on these estimates, the market currently trades at 19 to 20 times earnings which is still reasonable given the strong corporate fundamentals. Today, US equities also remain a safer harbor than foreign holdings due to the geopolitical environment and recessionary pressures on Europe’s doorstep. According to Goldman Sachs, US companies may be relatively insulated from geopolitical conflict, as 72% of S&P 500 revenue is derived domestically. We remain focused on quality businesses with strong balance sheets, defensible and growing business niches, and products and services with pricing power that enables management to pass on some of the inflationary pressures that may pressure operating profit margins.
Inflation and the war have dominated the headlines and investor focus, as Covid has taken a back seat. While the pandemic is not over, infection rates are down, and we have viable vaccination options to curtail the spread. As life normalizes, demand for products and services should increase. As Covid fades from our rearview mirror (hopefully!), inflation and the war are directly in our path – hindering our ability to move past the pandemic induced challenges. For example, the combination of the kinks in global supply chain (first Covid related, now Russia/Ukraine related) led to an unexpected decrease in supply combined with the multitude of well-intentioned stimulus programs that led to an unexpected increase in demand. The combination of these two powerful forces introduced an economic variable that has created much of the price inflation we are seeing now.
As a result, the Federal Reserve (Fed) is stepping in to address one of its two core mandates, price stability (inflation versus deflation). Chairman Powell and his band of “Fedspeakers” have done a marvelous job jawboning market interest rates higher by being transparent in their concerns and telegraphing their intentions of tighter monetary conditions. As such, the bond markets have done a lot of heavy lifting for the Fed, as short-term interest rates have risen quickly, flattening the difference between short- and long-term interest rates. This has resulted in much angst in the stock and bond markets as investors worry about the Fed overtightening and throwing the economy into recession. The other core mandate of the Fed is achieving full employment – which is being met as employment levels are high, participation rates are improving, and wages are rising. However, middle class workers are getting stuck in the age-old rut of the last 4 decades, as “real” (after inflation) wage gains are negative. Worded another way, an average worker’s standard of living has dropped over the last year because inflation has risen at a faster rate than wages.
Food and energy costs have risen sharply, crowding out spending on other items as every dollar of wages can only go so far. Clearly, economic data shows that many households have built ample savings from past stimulus programs while good paying jobs are easy to find. But, with receipt of stimulus checks far in the rear-view mirror, disposable income is falling, and personal savings rates have dropped by a little over 7% in the last 12-months, returning to 2014 levels of about 6.3%. With inflation pushing up prices for most goods and services and wage growth lagging inflation rates, revolving credit use has risen 15% to bridge the gap, taking it back near pre-covid levels. Consequently, falling disposable income will change consumer behavior resulting in demand destruction which will eventually ease inflation and slow economic growth. If growth sputters toward an economic contraction, the Fed may end up reversing course and go from tightening monetary policy (raising rates) to easing policy (cutting rates) to combat recessionary pressures. The Fed is aware of the longer-term balancing act, as are market pundits that excitedly provide play-by-play reporting like an announcer during Opening Day.
All of these factors have led to an increase in economic and market uncertainty which begets higher price volatility and the current negative bias in financial markets. The tone of the market will shift over time, as it always does, as the economic data presents itself and the Fed goes about its way with changes to monetary policy to meet its goals of full employment and price stability. Our goal will be to continue to focus on investment quality, cash flow within corporate income statements and portfolios, and being mindful of interest rate risk and credit risk. As 2022 has already thrown a few curveballs, we expect that the uncertainty and volatility will continue through much of the first half of the year. During the second half, inflation pressures should begin to ease as supply chain issues fade and the impact of higher interest rates engineered by the Fed begins to take hold.
All the Best,
Steve Taddie Peter Mueller
The discussions and opinions in this correspondence are for general information only and are not intended to provide investment advice. While taken from sources deemed to be accurate, HoyleCohen makes no representations about the accuracy of the information in the letter or its appropriateness for any given situation. HoyleCohen’s quarterly statements are provided as a convenience and we encourage clients to refer to custodian statements as well.