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We ended April with the S&P 500 down ~13.3% from its 2021 close, amid pessimism surrounding inflation, war in Europe, and the worst decline in technology stocks (using the Nasdaq Composite as a proxy) since 2008. The Nasdaq Composite was down 21% at the end of April year to date.
The Economy is flashing warning signals, the most severe of which are sharply declining measures of consumer confidence and the actual contraction in GDP we experienced in the first quarter.
The University of Michigan Consumer Sentiment Index is important because GDP growth is mostly (2/3) composed of consumer spending. When the consumer is growing pessimistic about their prospects and their ability to spend is being eroded by inflation at the same time, it is likely that at least some of the spending that has driven our recovery from the Covid crisis is going to pull back. Its latest print was on 4/30 at 65.2, which although is slightly up from the prior release in March, still represents one of the sharpest declines from a high-water mark in history.
Inflation is running at elevated levels, the most recent reading of the Consumer Price Index is 8.5%, the highest level since 1981. Things are worse for companies though, with the Producer Price Index coming in at 15.2% in its latest reading. The difference between these is a dramatic demonstration that companies believe they are unable to fully pass along price increases to customers without slowing new orders. This means we are now in an era of pressured margins, and the equity markets have been quick to pivot from rewarding sales growth (as they have been for years) into severely punishing companies that are not producing solid bottom line earnings. The Federal Reserve is widely expected to raise the overnight lending rate at the May meeting by 50 basis points (0.5%), but short-term interest rate futures indicate a high probability of the hike being 75 basis points (0.75%). To put this in perspective, the last time we had a 50-basis point hike was at the end of the Technology stock bubble in 2000. Markets appear to have discounted the half point hike, but a 75-basis point one could cause a selloff.
The good news is that we are finally seeing rates for corporate bonds yielding in the 3-4% range, which means income investors are able to earn more while reducing overall risk in their portfolios. While we are cautious about the economic environment, we see stocks holding up well, albeit with (potentially substantially) elevated volatility, for the rest of 2022.
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