Stocks Face the Realities of the Current Environment and Reset Lower
Unfortunately, rising interest rates, tightening monetary policies, record-high inflation, a war in Ukraine, slowing growth in China amid COVID-zero policies and lingering supply chain constraints have significantly dampened investor sentiment this year. As a result, stock prices have reset lower to the realities of the current environment. Notably, slowing global growth expectations are also increasing recession concerns and contributing to the decline in stock valuations. Bottom line: Investors are less willing to pay up for a future stream of earnings today when the future looks as uncertain as it does at the moment.
To Say April’s Performance was Disappointing is an Understatement; Tech Companies Show They’re Not Immune to Pressure
When it comes to stock performance in April, there isn’t any way to sugar-coat the pain — the month was atrocious. What was supposed to be a turnaround month for stock prices after weak Q1 performance (given April is historically the best performing month of the year for the S&P 500 Index) turned into one of the worst April showings in years. The S&P 500 Index finished last month down 8.8%, its worst April performance in at least 20 years and its first down start to the second quarter in 10 years. In addition, the NASDAQ Composite ended the month down 13.3%, its worst month since October 2008. Communication Services (down 15.8%), Consumer Discretionary (down 13.0%), and Info Tech (down 11.3%) all weighed significantly on the broader U.S. averages in April. And while Consumer Staples (+2.4%), Energy (down 1.6%), and Materials (down 3.5%) helped counter some of the heavier selling pressure across the S&P 500, their limited size/influence on the broader average was unable to reverse the significant declines seen in mega-cap stocks last month.
Outside of the tumble lower in stocks, West Texas Intermediate oil climbed nearly +4.0% to finish at $104.13 per barrel in April. Gold slipped 2.2% to end the month at $1,896.00 per ounce, and the U.S. Dollar Index rose +1.7%.
The final week of April was also one of the busiest weeks of the Q1 earnings season. The five most prominent tech companies on the planet provided a mixed bag of profit results and less-than-exciting outlooks for the current quarter. While mega-cap tech stocks as a whole didn’t necessarily overly disappoint in any one area, they offered little, if any, reasons that suggest these companies are immune from the pressures listed above. Frankly, that point was the biggest disappointment for the group last week. If one were hoping these industry giants would step in last week and save the market from its downswing with door-busting profit growth and deliver some brighter outlooks about the quarters ahead, they likely felt very disappointed following the results.
With that said, overall Q1 earnings themes continue to center around economic normalization, a consumer shift from goods to services (particularly in travel), a still healthy demand environment, and company pricing power in the face of inflation pressures. In addition, IT spending/Capex and cloud computing continue to stand out as a tailwind across Tech. However, pressures on supply chains (e.g., earnings commentary from Apple and Microsoft last week) and margins are an ongoing concern. With 55% of Q1’22 S&P 500 company results now in the bag, the blended earnings per share (EPS) growth rate stands at +7.1% year-over-year on sales growth of +12.2%. Although S&P 500 EPS and sales growth are coming in ahead of analyst estimates, investors appear to be discounting the earnings outperformance this time around and focusing instead on the macro-economic drivers that could weaken future profit trends.
U.S. Treasuries Move Higher; Investor’s Await this Week’s Fed Meeting Where They Expect a 50-Basis Point Rise in Rates
Importantly, the 10-year U.S. Treasury yield moved higher by over 50 basis points in April, an extraordinary backup in rates over such a short period. A number of hawkish commentaries from Federal Reserve members during the month outlining the need to move rates quickly higher to combat inflation pressures rapidly reset the market’s expectation for future rate policy. Not surprisingly, the backup in rates last month heavily weighed on stock prices, particularly across high-growth areas, where higher rates erode the value of future earnings.
Speaking of the Federal Reserve, the Fed’s FOMC will likely deliver a 50-basis point hike to its Fed funds target rate on Wednesday. As it stands today, the market also expects the Fed to shift its target rate higher by at least 50 basis points at the June and July meetings — marking the most aggressive rate actions in decades. As a result, the Fed funds rate could sit at 2.00% to 2.25% by the end of July and just slightly below the Fed’s stated “neutral rate” — where policy is neither accommodative nor restrictive to economic growth. In addition to the focus on rate policy this week, the FOMC is also expected to formally announce the start of its balance sheet runoff. At the March meeting, minutes suggested the Fed was comfortable reducing its nearly $9 trillion balance sheet by $95 billion a month.
Interestingly, while the Fed is readying to hike interest rates at the most aggressive pace in roughly 40 years, Q1’22 U.S. GDP showed the economy contracted by 1.4% quarter over quarter annualized (as reported last week). Although investors quickly looked past the backward-looking data, the decreased private investment inventory (including autos and retail) and lower exports and government spending reflect how quickly the economic landscape has shifted. On a brighter note, resilient domestic demand in Q1 showed the consumer remains on solid footing and willing to spend.
Investors Worry the Fed May be Willing to ‘Break’ the Economy to Tamp Down Inflation
Yet, here’s the rub for investors and why we believe stocks have had such a challenging year so far. Come rain or shine, the Fed is very likely to raise interest rates aggressively, at least through the front half of the year. And because inflation pressures are so elevated today, investors are worried the Fed will need to keep aggressively raising rates in the back half of the year, regardless of the negative consequences it might exert on growth. Said another way, investors fear the Fed may be willing to break the economy (at least a little) to tamp down inflation and return price stability to the market/economy.
While it remains to be seen if the Fed will need to be that aggressive on rate policy, today’s stock prices reflect a good portion of this worst-case scenario, in our view. Undoubtedly, investors will be parsing every word of this week’s policy statement and follow-up press conference from Fed Chair Powell for clues on the path forward for rate policy. Regardless, stock prices are likely to face added headwinds until a clear picture emerges on exactly how rapidly the Fed will need to raise rates to curb inflation. And since the Fed is still trying to figure out that critical piece of the equation for themselves, this week’s policy updates are unlikely to provide any clarity. Thus, investors should brace themselves for another volatile month in May.
During the week, nearly one-third of S&P 500 companies will report their Q1 earnings results, keeping investors busy against this week’s Fed meeting. And while April PMI/ISM manufacturing and services reports will be eyed for gleanings into economic activity, along with the March JOLTS report, Friday’s April nonfarm payrolls report will capture most of the attention. FactSet estimates call for April payrolls to grow by a healthy +400,000, following the U.S. economy adding +431,000 jobs in March. In addition, the unemployment rate is expected to hold steady at 3.6%.
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