The Outlook for Tighter Rate Policy Triggers More Volatility
In our view, the trading activity last week can be split into two distinct chapters. Before Thursday, stock prices were trending higher. The S&P 500 Index was on track for a solid week of gains and climbing back above its 200-day moving average. Additionally, corporate earnings reports were coming in better than expected during the week (sans Netflix on weak subscriber growth). With 20% of Q1’22 S&P 500 profit reports complete, the blended earnings per share (EPS) rate is higher by +6.6% y/y on sales growth of +11.1%, higher than the +4.7% and +10.7% expected at the end of March, respectively. Airlines pointed to a strong demand outlook, and reopening stocks were outperforming.
At least through the early part of the week, stocks looked like they were beginning to show early signs of stabilizing after a tough April outing so far and before this week’s heavy Q1 earnings release calendar. But Federal Reserve Chair Jerome Powell spoke at an IMF event on Thursday, and all those good vibes quickly reverted to what’s plagued stocks all year. Concerns over elevated inflation/rising interest rates and their dampening effects on growth, corporate profits, and ultimately stock prices.
When Powell Speaks, Investors Listen
Given the headwinds that tighter rate policies usually create for stock prices, when Mr. Powell talks, investors listen carefully. But unfortunately, the market didn’t care much for what the Fed Chair had to say last Thursday, even though many weren’t surprised by his statements.
Mr. Powell confirmed that a 50 basis point hike at the May Federal Open Market Committee (FOMC) meeting was on the table, and it’s appropriate in his view to be moving policy toward normal a little more quickly at the front of the year. While this has been a building consensus view across the market over recent weeks, hearing the Fed Chair echo those comments essentially sets that course as the “base case” for rate policy moving forward, in our view.
Market odds for 50 basis point moves at the May, June, and July FOMC meetings increased materially after Powell’s comments. Stocks sank lower through the rest of the week, and the U.S. dollar rose to its highest level since June 2020. Note: A strengthening dollar can weaken the earnings of multinationals when profits earned overseas are translated back into U.S. dollars for accounting purposes. As a result, stock declines accelerated on Friday, with the Dow shedding over 900 points to end the week (its worst day since October 2020), while the S&P 500 posted its worst day since March.
Although stock prices attempt to anticipate the future, it's important to note that Fed policy has barely budged off its ultra-accommodative stance in terms of actions. For example, the Federal Reserve just recently stopped buying government and agency bonds in March. The central bank hasn’t even begun reducing its balance sheet yet. And the Fed funds target rate has been lifted by a measly 25 basis points (starting from practically zero).
The NASDAQ and Russell 2000 Currently Sit in Bear Markets
Yet, the NASDAQ Composite and Russell 2000 Index currently sit in bear markets (down 20% or more from their all-time highs), the S&P 500 Index is back in a correction (down more than 10% from its all-time high), and 20+ Year U.S. Treasuries have lost nearly 19% year-to-date. In our view, hawkish Fed commentary (i.e., central bank jawboning), more restrictive policy statement language, and investor fears about unanchored inflation this year have gone a long way to temper market expectations and asset prices. Of course, it remains to be seen when this reset period in the market will be complete. Still, considering how far asset prices have already tumbled from their highs, we suspect we are approaching the later innings of stock prices adjusting to higher rates.
In other items of note, during the week, the ten-year U.S. Treasury yield finished at 2.89%, West Texas Intermediate (WTI) closed at $102.07 per barrel, and Gold ended at $1,931 per ounce. March's existing-home sales hit their slowest pace since June 2020, while housing starts touched their highest level since 2006. Russia intensified its attack on Ukraine in the east and south, the U.S. offered additional aid to Ukraine, and the European Union continued to contemplate oil sanctions on Moscow. In the background, investors grew more concerned over China’s “zero-COVID” policies and the lingering effects they could exert on supply chain disruptions.
Emmanuel Macron Secured a Second Term as French President; Earnings Ramp Up This Week
On Sunday, Emmanuel Macron secured a second term as French President after far-right leader Marine Le Pen conceded defeat in their run-off election. For investors, the result likely means the continuity of current economic and foreign policies. However, French President Macron will need his centrist party to perform well in the June parliamentary vote to fulfill his policy agenda.
Looking ahead, the heart of the earnings season calendar kicks off this week, with a host of mega-cap Tech companies slated to release results over the coming days. Profit reports from Meta Platforms (formally Facebook), Apple, Amazon, Alphabet (formerly Google), and Microsoft this week could go a long way in informing investors if the stock declines seen across Growth/Tech this year have started to run their course, or if prices have further room to fall. Additionally, a host of consumer-facing companies will report their first quarter results during the week and provide business outlooks (175 S&P 500 companies in all). These timely updates should provide a good deal of information on the current state of the consumer. Thus far, companies continue to point to inflation pressures as a primary concern while giving mixed signals on where they see consumer/business trends heading.
This week's economic docket includes a first look at Q1 U.S. GDP on Thursday, March PCE inflation on Friday, and a batch of home data. While the Q1 GDP data is backward-looking and should hold little sway on stock prices, most estimates suggest a material growth slowdown versus the fourth quarter. Inventory reductions and higher inflation likely hamstrung growth during the year's first three months. With that said, the report should reveal solid growth across business and residential investment.
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