May 2022 - Market Commentary
Stocks & Bonds Both Selloff During April
Monthly Market Summary
The S&P 500 Index produced a -8.8% total return during April, outperforming the Russell 2000 Index’s -9.9% total return.
Consumer Staples was the only S&P 500 sector to produce a positive return during April’s market selloff. Energy was the second-best performing sector as the price of crude oil traded around $100 per barrel. In contrast, the ‘Growth-style’ sectors, including Communication Services, Consumer Discretionary, and Technology, each traded more than -10% lower as interest rates soared higher.
Corporate investment grade bonds generated a -6.7% total return, underperforming corporate high yield bonds’ -4.2% total return.
The MSCI EAFE Index of global developed market stocks returned -6.7% during April, underperforming the MSCI Emerging Market Index’s -6.1% return.
Federal Reserve Policy Remains a Headwind for Equity & Credit Markets
April was another difficult month for both stock and bond markets. The S&P 500 Index traded -8.8% lower during the month, while the Bloomberg Bond U.S. Aggregate Index traded -3.8% lower. Federal Reserve policy remains the driving force as the central bank raises interest rates and prepares to shrink its balance sheet to ease inflation pressures. It is a difficult and delicate balancing act to pull off. Low interest rates and bond purchases stabilized the U.S. economy during the Covid pandemic, but removing the two pandemic-era monetary policies is proving to be disruptive.
Interest rates rose again during April as the 10-year U.S. Treasury yield surged +0.57% to 2.89%. While 0.57% may seem small on an absolute level, it significantly impacts how investors position portfolios. Why? Interest rates represent the cost of money and are used as an input to value company shares. The higher rate of interest applied to discount back a series of cash flows to today – some decades away – results in a lower present value of said asset. On a conceptual level, this is the messy valuation process the market is currently working through. It is trying to find the correct theoretical fair value of a company’s shares as interest rates rise. This is in addition to dealing with geopolitical tensions, new Covid lockdowns in China, and surging inflation.
Earnings Season Kicks Off
According to Factset, 55% of S&P-500 earnings have been reported thus far with an average growth rate of +7.1% year-over-year. If this holds true for the rest of the index, it will market the lowest earnings growth rate since 4Q of 2020 as corporations continue to battle severe logistical challenges, cost inflation, and labor shortages. For 2022, analysts are currently anticipating earnings growth of +10.3%. However, given the market volatility of late, we believe investors are focused on the potential for the U.S. GDP growth to decelerate after robust growth from 2H2020 to 1H2022. For example, according to the Institute for Supply-Chain Management, the April manufacturing index of 55.4 remains in growth mode (Growth > 50.0 > Contraction) but down from the 63.4 reading in April of 2021. Contacts in the survey indicate “Demand from consumers and businesses is proving encouragingly robust despite severe inflationary pressures, which intensified further during April.” Will growth begin to reaccelerate in 2H2022 as COVID and its related mandates hopefully exits our society along and supply-chains clear. Our belief is that the path of GDP growth is highly dependent on consumer’s appetite for higher levels of debt and consumption in light of high-single-digit inflation and higher borrowing costs relative to 2021.
Investors have become accustomed to robust returns from large-capitalization Technology giants, many of which reported quarterly earnings results last week. On the positive side, results from Microsoft (MSFT) were robust, Meta Platforms (FB) surprised investors to the upside, while Apple (AAPL) was more in line with analyst expectations. Netflix (NFLX) outlined a heightening competitive environment while Alphabet (GOOG) and Amazon (AMZN) results albeit strong on an absolute basis, have some traders fearing peak growth is behind them. In the very short run, individual stocks typically do not trade on fundamentals (more so on sentiment and technical analysis), and this select group of historically relatively high-quality businesses, has underperformed the broad market significantly on a year-to-date basis as investors take profits, seek other asset classes, and wait for results to re-accelerate.
What Can You Expect Moving Forward?
There is no easy answer or definitive path forward. This year’s selloff indicates some degree of tighter Federal Reserve policy is already priced into the market – we just do not know how much. In addition, the list of market uncertainties remains long, including corporate earnings quality, economic strength, and the path of Federal Reserve interest rate hikes. Until the market receives clarity on these uncertainties, volatility is likely to remain elevated.
During these choppy waters, we often remind clients that the S&P-500 increased in value by 17.9% per year over the last three years on average, 16.2% over the last five years, and 14.5% over the last ten years, according to Yahoo Finance. While past returns have been high by historical standards, it is not a future guarantee. The price you pay for such returns is intermittent periods of risk and drawdowns. The market experiences many peaks and valleys over the long term, and we believe the best wealth management process incorporates this understanding. Of course we understand that market related losses induce stress and unpleasant feelings, but it is important to try and not act emotionally when prices move against you and to stick to your goal based financial plan.
Please reach out to your Benchmark Advisory Team with any questions or comments.