Hiking Until It Hurts
After successive daily gains to begin the week, stocks staged a powerful relief rally in response to Wednesday’s Federal Open Market Committee (FOMC) announcement, aided by Fed Chair Powell’s comment that a 75-basis point hike was not under active consideration. Stocks, however, dropped the following day as investors reassessed the implications of a tighter monetary policy. Also on Thursday, the yield on the 10-year Treasury Note closed above three percent. News that worker productivity fell 7.5% and labor costs rose 11.6% in the first quarter fanned inflation fears and added to investor unease. Despite a better-than-expected employment report, stocks closed out the week with another day of losses amid volatile trading.4
By the Numbers
Short Term the S&P 500 lost 8.7% (total return) during April 2022, its worst month since March 2020.
Long-Term, the S&P 500 has gained +12.3% per year (total return) for the 100 months through 4/30/2022, gained +9.8% per year (total return) for the last 200 months, gained +8.8% per year (total return) for the last 300 months, and gained +10.8% per year (total return) for the last 400 months. The S&P 500 consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value-weighted index with each stock's weight in the index proportionate to its market value (source: BTN Research).
US inflation measured by the “Consumer Price Index,” was up +7.0% during 2021. About half of the three percentage points (out of the 7 percentage points) are a function of direct fiscal support from the US government and how American households spent the pandemic-related money (source: Federal Reserve Bank of SF).
Is Inflation the Reason? The US economy shrunk by an annualized 1.4% during the 1Q 2022, an 8.3 percentage point swing from +6.9% annualized growth recorded in the 4Q 2021. Other than the volatile swings in growth in 2020 during the first year of the pandemic, the US has not seen an 8.3 percentage point quarterly downward swing in the size of the US economy since the 4Q 1981 or 40 years ago when the economy went from a +4.9% growth rate to a 4.3% contraction quarter-over-quarter (source: Commerce Department).
U.S. equities continued their move lower as indicated by the S&P 500 which was down -3.26% on the week. In the U.S., smaller-sized companies underperformed their larger-sized counterparts, as the Russell 2000 shed -3.49%. International stocks as measured by the MSCI EAFE were negative again, down -2.20%, but outperforming domestic stocks. Emerging market stocks increased with the MSCI EM gaining +0.08%. U.S. investment-grade bonds were negative last week with the Bloomberg Barclays U.S. Aggregate Bond index down -by 1.47%.
Following the torrid 6.9% annualized GDP growth rate in the fourth quarter, economists had expected economic growth to moderate to about a one-percent gain in the first quarter. Instead, the economy shrank at an annualized rate of 1.4%, dented by a slowdown in inventory investment by businesses, a jump in the trade deficit, and a decline in defense spending. Consumer spending held up, rising 2.7%, though the gain was amid higher prices. Some economists expect the economy to resume its expansion for the remainder of the year, which may be one reason investors shrugged off the negative surprise.
Rate Hike Response
Markets are accustomed to hikes and drops in 0.25% increments historically, but given the unprecedented inflation, more drastic measures have been deemed necessary. Major U.S. equity indexes took last week mostly in stride, featuring some gains on Monday and Tuesday ahead of the Federal Reserve decision and press conference. The highest level of positive sentiment was seen on the day of the Fed announcement. Bulls sought shelter on Thursday and Friday, though, as the risk-off theme dominated the narrative, courtesy of higher 10-year note yields and a stronger U.S. dollar.
Yields Top 3.00%
10-year notes remained the featured headline last week, as yields topped 3.00%--closing last week at 3.122%, the highest level since 2018. Friday’s consumer credit data, a not-so-widely discussed metric released by the Federal Reserve, showed a whopper of a consumer debt figure and created further safe-haven demand. If wages are only rising slightly and costs are higher courtesy of inflation, it only makes sense that consumer debt would increase.
Traders will be heavily interested in how the 10-year note behaves this week, as April Consumer Price Index data is coming out on Wednesday.
U.S. Dollar Strength
In line with the higher interest rate theme, the U.S. dollar has risen against many of its sovereign currency counterparts. As interest rates of a country rise, the native currency usually does, too. Keep in mind that the higher U.S. dollar can contribute to weakness in dollar-denominated assets, as it takes fewer dollars to buy such assets.
April Jobs Growth
The latest nonfarm payroll data beat consensus estimates last week. 428,000 jobs were added in April, slightly above the Dow Jones estimate of 400,000. According to the data, particular strength existed in the leisure, hospitality, transportation, warehousing, and manufacturing sectors. The unemployment rate held steady at 3.6%.
Inflation Data on Tap
Drumroll, please…it’s that time of the month. Once again, we are due for inflation data via the Consumer Price Index (CPI). From the car dealer to the supermarket, we are all feeling the inflation pinch every day. As more time passes, we will be better able to ascertain the efficacy of the recent Federal Reserve rate hikes. Effects are not instantaneous, of course, and the full impacts of the rate hikes will take time. For the month of April (published in May), consensus economic estimates are for an 8.1% rise in the Consumer Price Index (CPI). 8.1% would be a lower number than March (8.5%). This data release will be heavily watched (even more than usual), as many economists and market participants are eager to see signs of peak inflation.
While the collective U.S. markets digest the new environment and associated headwinds, we should get a better understanding of the impact of current Fed policy soon, perhaps starting on Wednesday this week via CPI. We have now seen two back-to-back rate hikes, 0.25% in March and 0.50% in May, and more is on the way. So far, a 0.50% hike at the June Fed meeting stands as the highest probability, according to the CME FedWatch Tool. The sentiment is dynamic, though, and can change over the next five weeks leading up to the June Fed meeting. Also importantly, 10-year note yields have continued to climb, and one cannot help but wonder how many rate hikes are currently priced into the current 10-year yield. With that said, the focus this week will remain on the CPI data and 10-year note yield, as the major U.S. equity indexes look to find support and regain their footing. Until next time. Have a great week, and please feel free to contact me with any questions.
Stock Market Rover 05.09.2022
May 10, 2022